There’s a thought in the market that while the Wal-Mart consumer has been hit by the weaker housing market, the economy will be bailed out by rich people spending the proceeds of leveraged buy-outs.
It’s an appealing thought. It takes me back to my childhood, when we in the audience for a production of Peter Pan were able to bring Tinkerbell back to life by clapping loudly.
This “salvation through LBOs” was expressed by Bridgewater Associates, which in a recent issue of its “Daily Observations” noted, correctly, that high-end retailers’ stocks had been outperforming those of lower-end retailers. True, but backward-looking.
It is true there are sources of demand in the world other than the middle American consumer. Asian, European and Middle Eastern retail buyers are, for now, taking up the slack. But in the US itself, the increase in upper-end incomes from stock buy-outs will not be offsetting the weakness caused by the start of house de-leveraging.
Susan Sterne of Economic Analysis, who is based among the champion US consumers of Greenwich, Connecticut, says the high-end group “is just not big enough to make up for weakness in the middle and lower groups”. They also don’t have the same propensity to spend. Households with income over $90,000 a year spend 68 per cent of their income, compared to those with incomes of $40,000 to $50,000 a year, who spend 90 per cent of their income.
The group with $302,000 in income spends just $107,000. Also, as she notes, wealthy consumers increase spending at the beginning of an economic cycle, because they see improving income before other people. They don’t increase their spending late in the cycle, which is now. “It’s not that they don’t have the money. They always have the money. It’s psychological. They think they shouldn’t spend the money.”
Even with the estimated $300bn in private equity funds, waiting to be spent on rich people’s shares, the rich are not feeling all that happy. Consumer sentiment surveys in March showed declining sentiment in the highest-income group.
Where you are likely to see the LBO purchase proceeds thrown around like play money is in big auction houses’ sales towards the middle of this year.
Count on the contemporary and Impressionist and modern sales this month and the next to show very strong results. But let’s say they bump up the totals by another couple of hundred million on last year’s numbers. That’s not much compared with the losses being booked on busted subprime lenders.
Corporate treasurers are far more cautious than the private equity people, which is why company cash levels are still so high. While the deal people see the cheap and available money in their immediate future, the companies see weaker sales.
If anything, the high-end retailers may be at the top of their strength.
■Just when they’ve finally got Sarbanes-Oxley compliance under control, corporate accountants have another challenge to face – valuing intellectual property.
The Financial Accounting Standards Board in the US and the International Accounting Standards Board, and the US Securities and Exchange Commission, have put companies on notice that they have to identify and account for the financial value of their intellectual property. That applies most strictly to acquired property but the IASB now requires that companies value their internally developed IP, such as patents or copyrights.
The accounting firms have made a fitful start at estimating what these values are and, in doing so, have come up with estimates that between two thirds and three quarters of their clients’ value comes from their IP. Perhaps 1 or 2 per cent of that is systematically identified and disclosed.
“The compliance level has been close to zero,” says Douglas Graham, of Innovation International, an IP valuation consultancy in New York. The companies have had a reasonable excuse until now – there aren’t any systematic valuation methods.
Which is what Mr Graham, and others in the accounting profession, have been working to change. “The current method has been to estimate the value of royalty streams, or the present value of product lines, if the IP is incorporated into a product. The more sophisticated future methods look at macro methods, such as how often a patent is mentioned in the literature, how often it’s cited in litigation, or what kind of activity it’s used in.”
So there will be less of an excuse to avoid IP valuations from now on. Initially, the demand for IP valuation will be driven by compliance requirements and by investors who want to do better analysis.
Then companies may realise that they have a lot of under-exploited property on their hands, and royalty streams that can be securitised and sold off. Technology and biotech start-ups are willing to put a direct or implied value on a handful of patents. Why shouldn’t larger, more diversified holders of IP do the same?