Intangible Assets Playing an Important Role in M&A Deals

In the few years since Taiwan's government passed the Business Mergers and Acquisitions Act and the Financial Institution Merger Act, which provided a structural solution to many legal obstacles to business combinations, M&A have become an effective strategy for corporations seeking rapid growth, diversification, vertical or horizontal integration, and a decisive edge over their competitors.

The Importance of Intangible Assets Is Becoming Ever Clearer

A corporation's operating value is made up of its working capital, fixed assets, identifiable intangible assets and goodwill. In large M&A transactions, the share represented by intangible assets has gotten progressively larger. This is because, in the knowledge economy era, intellectual property has become such an important factor behind companies' competitive strength. According to U.S. government statistics, public corporations in America derive 70 of their value from intangible assets, and PricewaterhouseCoopers' own calculations show that, of the roughly US$250 million that exchanged hands in 100 American M&A deals between July 2001 and 2003, the purchase price allocation showed that 26% of the purchase price was for tangible assets, 22% was for intangible assets, and goodwill was 52%.

Intangible assets also play an important role in mergers and acquisitions by companies in Taiwan. In mid-2005, for example, BenQ was keen on acquiring European distribution channels and customers for its handsets - part of its effort to build a global brand - as well as gain access to patents for core 2G and 3G technology, so it decided to acquire Siemens' loss-making mobile phone unit in exchange for assets from the German company. Later, however, a dispute arose over the value of the assets, most of which were intangible. The matter was submitted to international arbitration in August 2006, and in September the post-merger company, renamed BenQ-Siemens, filed for bankruptcy protection. This action caused an uproar in Germany, and it could lead to BenQ losing the market channels and customer relationships it had its eyes on before the deal, as well as hurt the BenQ brand. Certainly, the value of the assets in the merger - tangible as well as intangible - merited closer scrutiny, but this case also illustrates the importance of intangible asset valuations in corporate acquisitions in general.

Another recent case was the merger between Internet portal Yam.com and Webs-tv.net. Like most Internet companies, the bulk of their assets are intangible ones, such as Internet addresses, customer relationships (high click-through rates, high numbers of registered users) and Internet portals. Therefore, the main focus of asset valuation and due diligence for the deal is certain to be on intangibles.

Accounting Standards Will Help Assess the Fair Value of Intangible Assets

The newly amended Statement of Financial Accounting Standards No. 25, "Business Combinations", and the recent SFAS 37, "Intangible Assets", clearly stipulate that the price premium in a corporate acquisition must be divided into goodwill and identifiable intangible assets. This move helps harmonize Taiwan's M&A accounting treatment with U.S. and international accounting standards, and it puts into practice so-called purchase price allocation, which reflects the underlying composition of a transaction's value.

Under rules laid down in current accounting standards, the purchaser in an acquisition must recognize, on the acquisition's effective date, the fair value of the acquired trademarks, patents, technology, in-house software, licenses and other intangible assets; in later years, identifiable intangible assets with limited useful lives must be amortized in line with their anticipated future consumption patterns. On the other hand, identifiable intangible assets with indefinite useful lives will be treated the same as goodwill; that is, with annual testing for impairment. These rules on recognition methods and accounting treatment for intangible assets will have a major impact on the future expression of operating results by post-M&A enterprises, and the importance of intangible assets in those results will continue to grow.

Valuation of Intangible Assets for M&A

Whether it is in evaluating M&A synergies or simulating their post-merger impact on financial statements, intangible asset valuation and due diligence are key to the success or failure of M&A deals. In view of this, intangible asset valuation over the course of a M&A transaction needs to include three major components: comprehensive planning at the initial stage, full and accurate evaluation and due diligence leading up to the deal, and effective post merger integration.

• Initial planning: It is necessary to thoroughly understand the enterprise's core value, the nature of its intangible assets, and the implications of the merger/acquisition; the feasibility of the merger must be assessed; and a detailed and accurate plan must be developed for on-site due diligence.
• As for valuations in the course of the investigation, it is necessary, on the one hand, to integrate technical, legal, financial, tax and industrial consulting, and to understand intangibles thoroughly (including their market characteristics, competitiveness, originality, legal protections and so on); on the other hand, it necessary to carry out an assessment of potential intangible assets (that is, a preliminary purchase price allocation), and to develop a good understanding of the sources of intangible asset values and their impact on future financial reports. Additionally, one needs to proper estimates of expected synergies, costs and risks, and to formulate a rigorous integration plan on the basis of those estimates.
• In terms of effective post-merger integration, then, what is required is effective implementation of the integration plan, along with regular tracking consolidation performance and formulation of improvement plans as needed.

• Since intangible assets have no physical form, there value can be hard to assess. The following are common reasons for incorrect valuations:
• Failure to understand the enterprise's core value and the special characteristics of its intangible assets;
• Neglect of external industrial and technological competition, such that the service lives of intangible assets are incorrectly estimated;
• Inability to extract intangible asset values individually, so that values are counted twice;
• Asymmetric information making it impossible to get complete information;
• Insufficiently rigorous analysis of the earnings-related utility from future use, underestimation of the deal's costs and risks, or overestimation of the expected synergies;
• Inappropriate valuation methods, or use of unrealistic numbers for comparisons when doing valuations;
• Insufficiently thoroughgoing on-site due diligence, where there is a failure to carry out comprehensive due diligence on the technological, legal, financial and other aspects of intangible assets.