Spotify's $26 Billion Value Is Hard to Put Your Finger On
What's the point of banks? The notion that they take our savings and lend them to businesses that want to buy equipment or build a factory is quaint, but often wrong. Nowadays banks would rather help you buy a house than create a company. 1
Lending against a property is pretty straightforward, compared to deciding whether a business will succeed. So perhaps banks have just become more risk-averse, as critics suggest. 2
Maybe, but the things owned by modern businesses have changed too. Increasingly, their chief assets are intangible -- patents, processes, brands, customer relationships and data, etc. Tangible stuff like robots and office space is less common.
And it's much harder to get a loan if you invest a lot in intangibles. Indeed, the shift might explain up to 20 percent of the switching of bank lending from business to housing, according to an IMF working paper. This might not affect a red-hot Silicon Valley startup, but other worthy -- though less fashionable -- enterprises may suffer. It doesn't help that the accounts of intangible-rich companies tend to appear bereft of assets under current accounting rules.
The shift to intangibles is here to stay, as Jonathan Haskel and Stian Westlake highlight in their recent book Capitalism without Capital. To make sure it's not just the Googles, Facebooks and Spotifys that prosper, finance and accounting need to adapt.
Intangible assets have some fantastic qualities. They're easy to scale up without creating lots of cost. But there are a couple of big drawbacks when financing them. First, intangibles tend to make lousy collateral. Banks often struggle to identify stuff they could easily detach and monetize in the event of insolvency. Hence, intangible-rich companies have less capacity to raise debt than those with physical assets such as utilities and phone companies.
Second, there's that point about intangibles often being invisible in accounting terms. Take music streamer Spotify Technology SA, which listed shares in New York last week. Its balance sheet shows just 73 million euros ($90 million) of property and equipment. 3 Net tangible assets correspond to less than one percent of its $26.3 billion market value, by my calculation. 4 That's not as unusual as you might think.
Spotify owns plenty of valuable assets -- its search algorithms, brand and customer data, for example. But selling them separately might be challenging, and they mostly don't appear on its balance sheet. That's because companies generally expense intangible investments like R&D when they occur, even though the benefit might be felt for years. 5
"If you ask companies for an inventory of their intangible assets some look at you like you're crazy," says Tuomas Nousiainen of investment firm Apollonian. "But if you tell a company, 'Your balance sheet says you're worth this,' they all say, 'Well of course we're worth more than that.' Then they start to tell you about their intangibles."
One consequence is that companies with lots of intangible assets tend to hold more cash, to pay for their own spending. This might suggest that all those big corporate cash piles aren't necessarily evidence that no-one wants to invest. It may just be plain old prudence. 6
Another result is that firms that want to grow will need to raise more equity. Even though U.S. public equity markets are shrinking, a flood of private capital is filling the gap -- creating scores of so-called "unicorns" with no pressing need to go public.
So what's the problem? For one, venture capital is sniffy about certain research-intensive industries, as American cleantech companies have discovered.
Meanwhile, in Europe neither public equity markets nor venture capital is as developed as in the U.S. Bank lending is much more prevalent, particularly for small firms. That might be holding back investments in intangibles, and hence productivity.
It would be useful if accountants (and their rule-setters) could help companies better highlight their intangible investments in financial filings. Because of the difficulty and subjectivity of valuing internally-generated assets, many companies are wary of putting them on the balance sheet even though some could, says Nousiainen. 8
Businesses could provide more qualitative information about their intangible assets too. 9 Finally, to reflect the need for equity to fund expansion, policymakers might want to rethink tax incentives that favor debt, as Haskel and Westlake suggest. 10
Companies may be able to flourish without physical capital, but intangible assets definitely carry a cost.
A theme explored at length in Lord Adair Turner's book "Between Debt and the Devil" and this study by Òscar Jordá, Moritz Schularick and Alan Taylor.
And, of course, home ownership has expanded and homes have become more costly.
Spotify leases offices and, increasingly, its data storage is handled by Google's cloud platform.
According to Bloomberg data as of December 31st 2017.
Intangibles generally only get added to the balance sheet when a company makes an acquisition.
See this study by Antonio Falato, Dalida Kadyrzhanova and Jae Sim.
See also this report from the UK's Intellectual Property Office.
IAS 38 allows intangibles to be recognized, providing they can be separated or sold, the cost can be measured reliably and their probable future economic benefits will flow to the entity.
See this European Commission report on intellectual property valuation. However, companies are often reluctant to publish information about intangibles because others might steal their ideas, as this paper points out.
Interest expenses are tax deductible, dividends aren't.
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James Boxell at email@example.com