October 20, 1999

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Economic Focus:
New Index Takes Measure
Of the Once Immeasurable
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By Sheila Muto

In California's knowledge economy, in which technology, patents and other intellectual property matter more than ever, how should "intangible assets" be valued and monitored?

The Patent & License Exchange Inc. thinks it has an answer. Set to officially launch this week, the Pasadena company has compiled an Intangible Asset Market Index -- actually five indexes -- that it says will track the values of patents, copyrights and trademarks world-wide in five technology sectors: advanced materials, such as modified alloys and polymers; automotive technology; express-package transport and logistics; health technology; and information technology.

Much like the 103-year-old Dow Jones Industrial Average, which provides a gauge of overall market strength and the state of the industrial economy, "the Intangible Asset Market Index will track the knowledge economy," says Nir Kossovsky, Patent & License Exchange's chief executive.

Patents, copyrights and other intellectual assets increasingly contribute to a company's stock-market value, yet aren't reported on the books. Although the U.S. Securities and Exchange Commission, which establishes the accounting and reporting standards for public companies, has no plans to take up the issue of intangible assets, a committee of the Financial Accounting Standards Board is studying it along with other practices for disclosing information not found in financial statements.

Brett Trueman, an accounting professor at the University of California-Berkeley, says the index could be useful in prompting "investors to really take into account the value of R&D and patents when they value companies," even though he believes Patent & License's approach falls short; among other concerns, he says, is that the index may overstate the value of intangible assets.

Still, many wonder whether this market index will reflect anything more than the degree of investors' enthusiasm for a group of companies.

To make decisions based on "generalities regarding intangibles is difficult," particularly given "the speed with which things fall into and out of favor," says Greg Rossmann, a managing director in San Francisco of Broadview International LLC, an investment-banking firm specializing in information-technology mergers and acquisitions.

Here's the way it works. Since Jan. 4, the Patent & License Exchange has tracked what it calls the "enterprise value" of 30 companies in each of the five technology sectors it covers. Enterprise value is calculated each day by subtracting a company's book value from its market capitalization. Each score is then averaged into one number representing the index for its sector.

To date, the most robust index has been information technology, rising about 150% since January. By contrast, the intangible assets of automotive technology look somewhat depressed.

The companies that make up each index must be predominantly "nonservice" and "technology-rich" businesses; close to "pure-play" technology companies; have minimal revenues and earnings; be small, young companies with minimal infrastructure; and be globally diverse.

These criteria were chosen to minimize the impact of such things as management's reputation, brand recognition and other so-called goodwill, says Alexander Arrow, Patent & License's vice president of financial operations and a former analyst at Wedbush Morgan Securities.

But, as a result, says Jim McCamant, editor of the Medical Technology Stock Letter in Berkeley, the companies selected for the health index, for example, are "a bizarre group...from market leaders to some very questionable companies."

Updated every trading day on the company's Web site, www.pl-x.com, the index is part of an effort by Patent & License to foster a bigger market for selling and buying patent licenses. The index "will help CEOs and CFOs formulate rational and financially sound plans" regarding what sectors to diversify into, says Mr. Kossovsky, the chief executive. Investors can benefit, too, he adds.

But many observers are skeptical. Because the index is based on market values, it "is useless to investors," says Baruch Lev, an accounting and finance professor at New York University. Moreover, adds Marc Bothwell, a portfolio manager at Credit Suisse Asset Management Inc. in New York, the approach "assumes the market is valuing everything correctly."

Messrs. Lev and Bothwell have developed their own method for calculating "knowledge capital," which involves taking the average of past and expected earnings, and subtracting the physical and financial assets. What's left, they say, is knowledge capital. The knowledge capital of biotech firm Amgen Inc. of Thousand Oaks, for example, was $20 billion as of June 30.

In contrast, Patent & License calculates the value of Amgen's intangible assets on that date at $27.5 billion. Says Mr. Arrow, "we're tracking intangible assets that are not generating cash. We purposely sought companies whose valuation was not affected by cash flow. We want to know the value of their ideas."

Caroline Mead, an intellectual-property attorney in San Francisco, says if it proves to be "a realistic index,...it would be extremely valuable" in giving a company "a better feel of where it fits in the world," particularly a "young company that's looking for investors."

A young company itself, Patent & License has yet to convey any transactions or sign up a subscriber to its exchange service since the firm was launched last January. But it has secured a former U.S. commissioner of patents and trademarks, Bruce Lehman, for its board, as well as establishing partnerships with Swiss Re Group for patent-validity insurance and Chicago Title Co. for escrow services.

In "economic planning and making policies...overlooking a source of wealth in the economy can make a huge difference," says Mr. Lehman. "We need to understand more about intangible assets" and "to have a starting point, which is what [Patent & License] has come up with."