Mark Hynes - thoughts on corporate disclosure

Opinions on changing rules, changing best practices, and their effect on investor relations officers.

Friday, July 08, 2005

Intangibles need formal reporting structure – enter the EBRC

The formal processes of financial disclosure have not kept pace with the needs of investors. Research shows that only about 25% of a company’s market value can be attributed to accounting book value, as captured by the existing GAAP model. The remaining 75% of market value is based upon “value drivers” - intangibles such as strategy, product innovation, people and customer loyalty, which are often NOT reported under disclosure requirements.
In early noughties (000’s), a casualty of the “changing fortunes” in tech stocks was the idea of these intangible business assets.
Amid bitter investor cynicism, soft items such as research and development, software, employee training and the power of brands were less likely to be counted as real assets on corporate balance sheets, alongside such traditional ‘old economy’ assets as factories, stocks and equipment. With stock prices falling in 2000, and some companies cooking the books, some investors – unsurprisingly - were asking what was real and what not. As a result unfortunately, a useful debate about this aspect of investor communication was put on hold.
At their worst, the promoters of Internet stocks wanted to have it both ways: to deduct such business expenses as R&D and advertising, whilst at the same time wanting investors to believe that these and other intangible investments should be counted as assets, not routine expenses as required by generally accepted accounting principles.
However, intangibles are recognised as assets when a company is acquired and the buyer pays more than so-called book value, which is based on the cost of tangible assets. If you bought AOL, for example, you would have to pay a lot more than the cost of the company's physical operations. You would have to pay for the AOL brand, which the company cannot count as an asset on its balance sheet, despite having spent significant money in building it.
In this more sober investment era, it is time revisit intangible business investments and the role they play in generating long-term profits. One organisation addressing this is the Enhanced Business Reporting Consortium, which is working toward consensus on an internationally recognized framework of voluntary guidelines for reporting that would make it easier to compare these intangibles.

The idea is that this framework would have internationally accepted definitions and measurements for industry-specific key performance indicators. There would be voluntary disclosure guidelines for information about opportunities, risks, strategies and plans, and about the quality, sustainability and variability of cash flows and earnings.

In the UK, the new OFR requirements recognise the importance of disclosing, business strategy, value drivers, risks and opportunities as a compliment to the financial statements. Enhanced Business Reporting aims to provide greater structure for these reports, making them easier for investors to use.

Tuesday, July 05, 2005

Changes in how inside information is distributed will affect IRO’s.

Issuers face greatly changed rules on how they must disseminate inside information, following the publication of the advice on transparency published this week. News must be distributed (pushed) to news agencies and newspapers across the EU, ‘fast’ and as close to simultaneously as possible. Issuers can undertake this themselves (in which case they must follow certain strict requirements) or they can use one of the competing service providers.

The Transparency Obligations Directive will be implemented in member states of the EU, starting in January next year. It introduces Europe rules – for the first time – on how news should be sent out, as well as a common standard for disclosure of major shareholdings (above 5%), and issues on half yearly reporting and equivalence of home country requirements for non EU issuers.

First the requirements. Issuers will need to make a choice as to whether they manage the distribution process themselves. In my view the vast majority will use a service provider, simply because life is too short. Specialist skills such as sending news electronically, with meta data identifying the issuer, using secure internet protocols, to newspapers, news agencies and key retail investor websites, are not something most issuers have – or wish to develop.

The good news is that by introducing competition, the regulators have ensured that service provider costs will be kept to a minimum. Previously, where an exchange has operated a monopoly, the costs have been “buried” in a listing fee. Now these costs will become transparent. If the UK – where a similar regime was introduced in 2002 – is anexample, costs will become highly competitive.

One challenge for issuers will be in ensuring that their chosen service provider has the skills necessary. The new rules remove the requirement for service providers to be ‘approved’ by their regulator, leaving the issuers to make their own choices. And since meeting disclosure is now judged by delivery to a service provider (not when the announcement is in the public domain) the choice is critical.
My advice is to look for providers that have published their own ‘audit’. This will demonstrate how they have meet the requirements, and reassure you that the distribution will be managed effectively.