The Vodacom Conroversy - August update, 2005





August 2005




NEWS UPDATE

The Interbrand table of South Africa’s most valuable brands launched last May had a very positive ramification for us. As a result of Vodacom being placed third after its major rival, MTN and at a value that seemed miserly compared to the growth the giant of the market has experienced, we were commissioned to estimate an alternative value.

Interbrand group deputy chairman, Tom Blackett, and I were both interviewed by Jeremy Maggs on his Sunday morning media programme at the height of the fuss. Tom was quite comfortable with an alterative valuation being called for as long as it used the same data and was comparable in method

Well the valuation is now out. It is R21 billion : three and a bit times the R6, 5 billion attributed to the brand in May. Are these values comparable? And were the same data used?

Drawing parallels

The method used by Interbrand today is different to the one that was used prior to the middle 1990s. If that method had been employed the two valuations would not have been comparable because the original method applied a multiple to the weighted average of the previous three years profit. BrandMetrics has always used discounted cash flow (DCF) and that is the basis of the current Interbrand approach. From that point of view they are comparable.

Second, they both calculate the economic profit generated by the brand. A factor is then estimated which when applied to the economic profit isolates the portion that can be attributed to the brand. Interbrand calls this the Role of the Brand; at BrandMetrics it is described as the Brand Premium Profit (BPP). The methods used to reach these conclusions differ slightly but achieve the same goal.

Where they diverge

Where the two approaches differ is in the determination of the discount rate and in the projection of earnings for the DCF calculation.

Present value calculations are highly sensitive to the discount rate used. We have found that a single percentage change can make a substantial difference to the valuation. For that reason we elected to use the tools of corporate finance. The Capital Asset Pricing Model (CAPM) is often subject to mauling by corporate finance academics. In the end they agree that it is as good as we are likely to get, and most valuers and analysts use it.

In South Africa we work with Professor Leon Brummer of the Bureau for Financial Analysis (BFA) to obtain the discount rate. He draws on JSE data and his huge database of listed company returns to calculate this number. In other markets in which we have conducted valuations we are always able to find a source for data to make CAPM work. Thus the discount rate is a properly calculated Weighted Average Cost of Capital (WACC).

Interbrand employs a different method. They have developed an approach, which adds a derived Brand Premium to the risk free rate. They call the result the Brand Risk Rate. This brand strength derived risk premium does the same job as the CAPM risk premium but is entirely related to a range of variables that together form four influencing factors: market position, customer franchise, image and support. Interbrand’s assessment of these four factors results in a score which converts into the Brand Premium. A risk free brand has no brand premium; a risky brand attracts a high premium. So the discount rate is a risk free rate such as a government bond plus a risk premium derived from marketing related influences.

Because there is such a difference in the methods it is quite likely that it is in this area that major divergences could occur. The rate used in the BrandMetrics valuation was 13,58% based on data from the appropriate period. We do not know what rate was used in the Interbrand calculation.

Methodological inexactitudes?

The other difference is in the DCF approach used. Brands are a new type of asset and it does not follow that traditional valuation methods apply. The difficultly lies in the long-lived nature of the brand asset. Most successful brands last for many years: quite a few for a century or more and show no signs of ware and tare. This phenomenon has to be taken into account.



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The Interbrand approach is based on a three to five year projection of brand related earnings which are then discounted to their present value (they call this net present value) and capitalised. According to their own literature, Interbrand then estimate a growing perpetuity (which they call an annuity to perpetuity) to take account of this long-lived nature and add this to the DCF number. They may or may not have used this approach for the list; this is not stated. However the annuity normally more than doubles the capitalised present value calculation and is therefore a vital part of their methodology.

BrandMetrics, rightly or wrongly, (we naturally are convinced that it is correct) pioneered a way to reflect the full economic useful life of the brand. We use inputs from market research and couple this with an analysis of the product category. The market research allows us to place the brand we are valuing in a competitive context compared with the strongest and weakest brands in the category. The category evaluation sets the time parameters for the DCF by establishing the capability of the category to sustain whatever level of economic profit the brands within it are currently earning. We transform the survey-based data mathematically into economic form and the model is able to work out the number of years for which the earnings of the brand being valued should be projected. Thus each brand has its own unique DCF curve. Have a look at our web site www.brandmetrics.com for a more graphic illustration of this or give us a call and let us show you personally with our new presentation.

The world is a rough place

BrandMetrics is the “new boy on the block” and ours is a local South African product. We are very aware that we are challenging the world leader; which is a little scary! We do not think though that our size or provenance disallows us from being so bold.

Brand valuation is at a vital cross roads. As the accounting standards call increasingly for intangibles to be valued (We trust you read our last update which dealt with this) and include brands under that heading, there is no reason, from what we have read to date, that our approach should not be used as a tool for measuring the fair value of the brand asset: acquired or internally generated. After all, the Interbrand methodology itself is evolving and bears little resemblance to the approach that was launched twenty years ago and it would not be the first time that a South African innovation has taken on the world and won. We certainly are raring to give it a try.