French Chamber of Commerce - Beijing - October 2010

Brett Shadbolt, Censere CEO, was invited on 19 October 2010 by the M&A committee of the French Chamber of Commerce in Beijing, China, to do a presentation about "Valuation of Intangibles in M&A operations". Brett Shadbolt was speaking alongside Thierry Labarre, Mazars Mainland China Managing, Partner and Christine Lambert-Goué Managing Director at Invest Securities

Related links:

CCI France China: http://www.ccifc.org/Mazars: http://www.mazars.cn/content/view/full/51112

Censere speaking at Technology Transfer Forum in Shenzhen - January 2011

Brett Shadbolt, Censere CEO, was invited on 13 January 2011 in Shenzhen, China, to discuss with Rouse, a leading global intellectual property firm, and CTEX, China Technology Exchange about IP valuation, license pricing and negotiation.

Related link:

- IAM Article: http://www.iam-magazine.com/blog/Detail.aspx?g=78fee581-326e-435e-96bb-58d957c30d65

 

Chinese New Year Wishes

We will not be sending a Chinese New Year email to everyone in order to help prevent your inboxes being overloaded, but would like to thank all our partners and clients for their past support and wish you all a happy and prosperous year of the Rabbit.

Congratulations to China Kanghui

Censere congratulates China Kanghui Holdings on its successful listing on NYSE.

We are proud to have been able to assist China Kanghui as it prepared for this important step.

Censere Maldives Office

Censere is pleased to advise that we have opened our 10th office, in the Maldives. Contact details as follows:

Censere Group Pvt. Ltd.M. Banf Villa (Level 6B)Majeedhee MaguMale'Republic of Maldives

Tel: +960 3009585Fax: +960 3309590Email: This email address is being protected from spambots. You need JavaScript enabled to view it. further information, please contact Abdulla Mohamed or Brett Shadbolt directly.

Censere Opens in Tokyo

We are very pleased to announce the opening of our Representative office in Tokyo. This comes hot on the heels of our strategic alliance with Global Partners Consulting in Japan and will strengthen our ability to assist Japanese clients both within Japan and around Asia Pacific.

For further information please contact our Tokyo office directly.

 

Censere forms strategic Alliance with GPC

We are pleased to announce that Censere Group and Global Partners Consulting of Japan have formed a strategic alliance to provide our combined services to Japanese Clients and foreign clients coming to Japan.

GPC is a Tokyo-based firm specialising in accounting, tax advisory and private equity fund-raising activities. They provide support to Japanese clients for IPO, M&A and restructuring and are experienced in J-GAAP/IFRS translation work.

Together with Censere's valuation and transaction support services we are able to offer seamless advice to Japanese firms looking to list in Singapore or Hong Kong and provide assistance for offshore M&A by Japanese clients.

For foreign firms seeking an entry to Japan we can also assist in M&A and Tokyo-Aim listing advice.

Our alliance with GPC is a major development for Censere and will see us opening a Representative Office in Tokyo to provide closer support to GPC and our mutual clients.

According to IFRS 2, share-based payment transactions are categorized as three types: equity-settled, cash-settled, and a choice of settlement in equity or in cash. Employee share option plan (ESOP) is an example of equity-settled transactions. Share Appreciation Rights (SAR) falls into the category of cash-settled transactions. IFRS 2 covers recognition, measurement and disclosure of share-based payment transactions. The recognition and measurement are affected by both transaction types and market or non-market performance conditions. Market conditions are defined as the conditions upon which the exercise price, vesting, or exercisability of an equity instrument depends on the market price of the entity's equity instruments. Level of disclosures has also been required to raise under the standard. Among the accounting treatments, estimating the fair value of the ESO from the perspective of the employer will be the main focus to the management of most companies. It could also be the most difficult issue when applying this new standard. Under IFRS 2, both listed and unlisted entities will need to estimate the fair value of its ESO that were granted after 7 November 2002 and had not yet vested on 1 January 2005. Valuation should be determined by reference to market price. If market price of share options does not exist, IFRS 2 would require an option valuation model be applied for the valuation of ESO. All option pricing models should take into account, as a minimum, the following factors: (a) the exercise price of the option; (b) the life of the option; (c) the current price of the underlying shares; (d) the expected volatility of the share price; (e) the dividends expected on the shares (if appropriate); and (f) the risk-free interest rate for the life of the option. Above are also the common factors that influence market value of exchange traded options. Since they could have a significant impact on the option valuation, the determination of these variables requires a large amount of professional judgements and assumptions, especially for shares of unlisted entities. IFRS 2 provides application guidance on estimating the fair value of share options granted. In addition to the six factors above, it requires that other factors that knowledgeable, willing market participants would consider in setting the price shall also be taken into account. To properly evaluate ESO, the additional elements could include vesting period, forfeitability, possibility of early exercise and non transferability. All these restrictions and factors will have an effect to reduce the value of option. Also, separating options by groups of recipients with relatively homogeneous exercise behaviour for more accurate valuation should also be considered. According to IFRS 2, adoption of pricing model for ESO valuation is part of an entity's selection of new accounting policies and should be applied consistently to similar share-based payment transactions. In past, Black Scholes model is the most commonly used methodology for option valuation. Binomial model is another widely accepted model. IFRS 2 does not specify which pricing model should be used or is preferred. However, it indicates that Black Scholes model could fail to incorporate some unique features for ESO valuation, such as possibility of early exercise and change of expected volatility over the option's life. Comparison of different option pricing models is discussed in more details in a separate article. In general, more flexible option pricing models can be applied to incorporate the variety of factors and assumptions in ESO valuation. In rare cases, the entity may be unable to estimate reliably the fair value of the equity instruments granted at the measurement date. In these rare cases only, the entity shall instead measure the equity instruments at their intrinsic value. Given the potential impact on their bottom line and the professional judgements required for various pricing models, it is widely expected that more companies will seek opinion from independent professionals in valuing their ESO. Independent valuer can help the management better gauge and understand the existing compensation package with share options. Should you require any assistance for ESO valuation or related advisory service, please do not hesitate to contact us.

On another occasion a chemical plant replaced an essential catalyst in the reactor with an improved version. The reactor, which had been the limiting factor for the production rate, could now produce much more and was no longer the bottleneck. As a result the production rate of the plant increased considerably and the the Production Manager got a promotion. These are clear examples that design capacity is not an iron clad figure carved in stone. The term design capacity is often misunderstood. Add to this the confusion the term 'capacity' causes. The word is used in conjunction with design, actual, nameplate, theoretical, installed, proven, economical etc. Sometimes production rate is used and can be expressed per hour, day, month or year. For simplicity and clarity we define capacity as the ability of a facility (factory/plant) to produce an quantity of product(s) in a certain time frame at a defined quality. It could be the number of ships built at a shipyard per year, the m2 of ceramic floor tiles produced per hour or the tons of gasoline in a month in an oil refinery. It is quite a normal experience that the intended (design) capacity differs from the actual one. Unfortunately more often than not the actual is lower than the design. There is a great time lag between the conception of a facility and the actual construction and start up. A time span of 2-3 years can be quite common. The design was made years before the facility actually starts producing and during this time conditions might have changed. Cooling water temperature is actually higher, quality of feedstock material worse than assumed, product quality more stringent or government regulations require amended operating conditions. Possibly even simple errors in the assumptions or in the calculations could be a reason, although this would never be admitted. These are just a few examples, but certainly anyone in a manufacturing or engineering position recognises these and can add to this list from his or her own experience. In the initial years it might not even be apparent that the facility is not able to produce the intended (design) amount of product. It takes time to build up a market, sales are slowly increasing, production is lower than the design capacity calls for and the facility is therefore underutilised. However at a certain stage it may become evident that the facility cannot produce what everybody expected and what was promised by the design. Then the blame game might start. Management blames the Operations staff that they cannot operate the facility properly, Operations replies that Management never allocated enough money to install the right quality equipment, both Management and Operations blame the design contractor for a lousy job and the story might go on for years. In the meantime the production certainly will not increase if adequate measures are not taken. Instead, it would be much more productive if proper analysis is made of the actual production process versus the design. Properly controlled and well defined test runs should be carried out under representative conditions to assess the capacity of the facility and of each individual piece of equipment. This information can then be used to determine where the bottlenecks in the facility are and might even offer possible solutions to remove the bottlenecks. As an alternative, Management could consider appointing an experienced, professional consultant to aid them in the efforts mentioned above. This approach has a number of advantages. As plant management is less involved they will have more time to concentrate on their core activity of running the facility. Moreover the consultant’s experience is not confined to this particular facility but covers a much wider range. Last but not least and frequently overlooked outside experience offers a fresh look. If you would like more information concerning Censere's Technical advisory services, please contact your nearest office.

Let's now examine each in more detail. Management is responsible for ensuring that a company's assets are properly utilised and protected. Insurance addresses the issue of protection, however, if the sums insured do not properly reflect the possible risk then management is either wasting money on excess premiums (in the case of over-insuring) or taking unnecessary risk (in the case of under-insuring). Most, if not all, policies contain a co-insurance clause (also known as the "Condition of Average Clause") which comes into effect when a loss occurs and it is determined that the Sum Insured is less than the true value ("Value at Risk"). The co-insurance clause basically means that if the assets are under-insured, the company is opting to carry the risk for the difference between the Value at Risk and the Sum Insured. In essence this means that the amount paid by an insurer in the event of a loss equals the actual loss multiplied by the ratio of the Sum Insured divided by the Value at Risk. A simplified example follows: Sum Insured: US$8 million Value at Risk: US$10 million Therefore the company is co-insuring the difference of US$2 million. If a loss occurs which costs US$5 million to rectify, the insurance company will only pay US$4 million and the company will have to pay the remaining US$1 million (US$8m / US$10m = 80%, US$5m * 80% = US$4m). On the other side of the coin, over-insuring is purely a waste of money. Insurance companies will never pay out more than assets are worth regardless of the how much cover you have. In other words, if you insure for 20% more than your assets are worth, the insurance company will only pay out up to the actual value of the assets, the remaining cover is redundant and the premiums on this cover could have been saved. As for how insurance valuations can assist in the settlement of a claim, simply having had a valuation done can help reduce settlement time as the insurers are less likely to suspect under-insurance and test for this in order to apply the coinsurance clause. The information gathered in the valuation process – photographs, drawings, specific machine information, etc – can also help determine exactly what was on site and provide corroborating evidence in proving the claim. The valuers can also be brought in to work with the loss adjusters and assist them in determining the current value of the loss. Regular insurance valuations are cost effective – once a valuation program has been put in place, it can help ensure that you are managing your insurance costs and cover effectively and provide support for claims. One important aspect of an insurance valuation program is determining what to value and how frequently, this is something that your valuers can help you decide and will depend on the nature of your business – how quickly costs change, how many similar locations you might operate from, whether there are long term economic factors which impact on asset utilisation, etc. While many insurance programs are similar, no two are the same – make sure your valuers are properly tailoring their services to your specific needs.

First we have to set a few ground-rules and provide a framework for our discussion. There are many different types of valuation, almost as many as there are reasons for wanting to determine a value. Before even starting the valuation, the valuer has to discuss with his client the purpose of the valuation and who will be the target audience. If the valuation is for supporting an end of year financial audit, Fair Value will most likely be the correct basis of value. If the valuation is required to assist in an acquisition of the asset, Market Value will most likely be preferred. If the valuation is required for insolvency purposes or the seller is under duress, then Forced Sale Value might be more appropriate. The key is to ensure that the basis of valuation is matched to the purpose of valuation. It also follows that you should not blindly take a valuation prepared for one purpose and try to use it for an alternative purpose, it may be completely inappropriate. For the purposes of this discussion, and unless indicated otherwise in future articles, we will assume that the basis of valuation is Market Value. Unfortunately, having decided on the basis of value doesn't solve all our problems as there are many different standards which define or describe how valuations should be performed. While it is important to select the appropriate basis of valuation, it is equally important to use the correct set of valuation standards for the situation as well. We will use the International Asset Valuation Standards as the basis for all our future discussions, again, unless indicated to the contrary. Having settled on the valuation standards and the basis of valuation, we can now look at the definition of Market Value. The International Asset Valuation Standards define Market Value as “the estimated amount for which an asset should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s-length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and without compulsion”. While we could devote the rest of this article and the better part of a textbook on exactly what this means, we won't. We merely provide the definition here to help set the scene for intellectual property valuation. Now, on to a few key rules which relate to intellectual property and valuation. Firstly, simply because something has cost money to develop doesn't mean that it has value – cost does not equal value. Secondly, just because something has a value to you doesn't mean that it has a market value – market value is based on the concept of value in exchange and if the asset cannot to transferred or exchanged, it has no market value as a standalone asset. That doesn't mean it has no value, it simply means that it may not have a market value if sold as a separate asset, it may need to be bundled with other assets to realise its value. This is especially true of intellectual property and other intangible assets which cannot be clearly identified, described or legally defined, they add value to a business and enhance its Market Value, but may not meet the criteria for valuation as separate assets. For intangible assets to have a market value, they must meet the following criteria. Failure to meet any one of the following means that the asset cannot have a Market Value by itself and will need to be bundled together with other assets to be ascribed a Market Value.

The asset must be able to be identified and defined. If it cannot be fully described then it cannot be transferred.There must be some physical manifestation of the asset – innovations can be defined by patents, business practices can be described in procedures or work rules, manufacturing rights can be defined in license agreements.It must be separable from the other assets with which it is used. By themselves some items have no Market Value as they are unable to be transferred to a third party.An asset must have a date of creation. All assets come into being at a specific date, this date must be known and able to be proven.An asset must generate measurable economic benefits if it is to have a market value. If we cannot reliably identify cash flows attributable to an asset, it cannot be valued by itself. This doesn't mean it won't have value as part of a bundle of assets.

Having established a few basic parameters for the valuation and the assets being valued, we define below each of the three approaches to value: The Cost Approach The Cost Approach considers the cost to reproduce or replace in new condition the assets appraised in accordance with current market prices for similar assets, with allowance for accrued depreciation arising from physical, functional and economic causes. The cost approach generally furnishes the most reliable indication of value for assets without a known market. The Market Approach The Market Approach considers prices recently paid for similar assets, with adjustments made to indicate market prices to reflect condition and utility of the appraised assets relative to the market comparative. Assets for which there is an established market may be appraised by this approach. The Income Approach The Income Approach is the conversion of expected periodic benefits of ownership into an indication of value. It is based on the principle that an informed buyer would pay no more for an asset than an amount equal to the present worth of anticipated future benefits (income) from the same or equivalent project with similar risks. In a perfect world, each of the three approaches should yield the same result. Unfortunately, as we all know, we do not live in a perfect world. Therefore, part of the valuer's skill lies in selecting the correct valuation methods for the assets being valued given the specific circumstances of the valuation. While we have only identified the three basic approaches to value in this article, it is worth noting that there are numerous methods based on these approaches, many of which combine elements of two or more of the three basic approaches. Future articles will examine each of the three approaches in detail and describe how these can be applied to intellectual property and other intangible assets.

As valuers, our role is to gauge the sentiment of a specific market at a particular point in time and draw conclusions concerning the worth of one company which operates within that market. In order to conduct a valuation of a particular company, it is necessary to obtain a complete understanding of the internal workings of the company, the specific industry sector it operates in and the wider business environment. In a nutshell, it is obtaining complete and unbiased data pertaining to these areas which valuers are most concerned with.

If we observe America about 125 years ago when the gold rush was at its height and people would register their claims at a title registration office. This process saw the beginning of Title Insurance - claimants who registered were given a guarantee that they’d have a legal right to own and develop. Nowadays, in America no real estate transaction happens without Title Insurance.

With that in mind, Paul Boldy of Boldy Associates, began to introduce title insurance into Asia 4 years ago beginning in Hong Kong and Korea. Paul works with 2 of the world’s leading title insurance firms, Land American and Stewart title. Paul discovered that Title Insurance helps speed up the transaction for any buyer in any market but is especially useful in Asia with the main markets being China, India, Korea and Thailand.

Over the recent years we have seen increasing trends towards understanding and managing potential environmental liabilities and risks associated with investments. These trends have developed alongside the implementation of new and existing requirements on property transactions and operational performance. In addition there is an increasing trend of financial institutions requiring environmental risks to be considered prior to approving financing. Documenting the environmental risk status at the time of transfer is now seen as standard practice by many investors throughout the region.

An environmental risk assessment conducted prior to completion can be beneficial to both parties. Not only does it identify the compliance status, but also indicates areas of potential concern such as contaminated land and asbestos. By identifying these issues at the onset reduces potential futures costs in litigation and remediation, improves budgeting, and allows for opportunities in risk and cost reduction and liability management.

Defined benefit plans are classified as post-employment plans where the obligation of the entity is to provide the agreed benefits to current and former employees, usually based on some benefit formulas. Under benefit plans actuarial risk and investment risk fall, in substance, on the entity. If actuarial and investment experience is worse than expected, the entity’s obligation may be increased.

Accounting for defined benefit plans is complex because actuarial assumptions are required to measure the liability and the expense and there is a possibility of actuarial gains and losses. Moreover, the benefit obligations are measured on a discounted basis because they may be settled many years after the employees render the related service.

Several countries have adopted the IFRS 3 and some of the effective dates are as follow:

Country		Standard		Effective date
International		IFRS 3		31st March 2004
Australia		AASB 3		1st January 2005
Hong Kong		HK FRS 3		1st January 2005
Malaysia		FRS 3		1st January 2006
New Zealand		NZ FRS 3		1st January 2007 1
Singapore		FRS 103		1st July 2004
US GAAP		FAS 141		1st July 2001 2

1 Early adoption is permitted only if entity complies with NZ FRS 1 on 1 January 2005.
2 FAS141 predates the introduction of IFRS 3, but contains many similar provisions. However, there are key differences in certain areas.

Financial reporting rules for acquisitions were radically changed by the introduction of the IFRS 3. The new standard requires that the Purchase Method to be applied for all acquisitions.

Intellectual Capital Due Diligence This covers four key areas of the business; the business recipe, the internal structural capital, human capital and external structural capital. The following chart shows these and the topics underlying each area:

 

As well as determining the current status of the business in terms of these four areas, we also look at what measures the business is taking to improve its position and what risks it faces in these areas. The intellectual capital assessment is forward-looking, as opposed to financial reports which deal with historical fact, and is therefore a much better predictor of future performance.

In performing intellectual capital due diligence, senior management, middle management, customers, suppliers, industry experts and other stakeholders such as bankers, legal advisors, insurance brokers and industry experts are interviewed in a structured manner. The results of the interviews, both qualitative and quantitative responses, are carefully collated and cross-checked for consistency and then analysed and compared against industry benchmarks. The final results can provide useful insights for both the company and its sponsor and are often used beyond the IPO issue itself, frequently being worked into future business models. Technical Due Diligence This aspect of due diligence doesn't apply to all IPO's. This is most relevant to manufacturing companies, infrastructure companies or high-technology companies where future earnings are largely dependent upon physical assets of some sort. For manufacturing companies, future earnings are directly related to production capacity, quality of outputs and ability to withstand (or respond to) future technological changes. The technical due diligence report deals with these issues. Typically an industry expert would review the existing manufacturing facilities and future capital expenditure budgets against stated operating parameters and expected production volumes. The key result is a manufacturing capacity analysis. Other possible areas of investigation include susceptibility to energy cost increases, reliance on raw materials, operating efficiency and/or technological feasibility. In the case of infrastructure companies, they are usually contractually obliged to meet certain availability criteria. Failure to meet stipulated availability criteria will not only reduce revenue it will usually result in financial penalties. The capacity and condition of physical assets, operations management and maintenance procedures are critical meeting these obligations. Censere provides comprehensive intellectual capital and technical due diligence services throughout Asia Pacific. We have in-house technical expertise in many industry sectors and have affiliations with other experts in most other industry sectors. For more information on either of these services, please contact your nearest office.

Watch this space!

Censere is preparing for the launch of its new website. We hope our new site will make it easier for you to find what you want and provide more informative articles.

Brett Shadbolt will talk to students at City University of Hong Kong on Saturday, 30th January 2010. His presentation is titled "Valuation of Intangibles - Theory and Practice".

Censere and Stephenson Harwood are presenting a joint seminar about the commercialisation of intellectual property 17th September 2009. For further information please contact either Censere in HK or Stephenson Harwood in HK.