MISSION INTANGIBLE

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MISSION:INTANGIBLE, the blog of the Intangible Asset Finance Society, offers critical comments on intangible asset, corporate reputation, and finance; supplemented by quantitative reputation metrics. Intangible assets include business processes, patents, trademarks; reputations for ethics and integrity; quality, safety, sustainability, security, and resilience; and comprise 70% of the average company's value. MISSION:INTANGIBLE is a registered trademark of the Intangible Asset Finance Society.

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Massey Energy: Ain't no mountain high enough

C. HUYGENS - Wednesday, June 01, 2011
In a curious twist on the Ashford/Simpson love duet, Massey Energy (NYSE:MEE) shareholders have signaled that they intend to pursue claims aggressively against the board of directors notwithstanding efforts by the latter to make a wash of the whole thing. The matter is now before the West Virginia State Supreme Court.

The case elements center about liability, reputation, and board oversight. Simply put, plaintiffs allege that the Board of Directors failed in its Duty of Loyalty by not ensuring that safety processes were being implemented. Safety, as we have noted before, is a key business process underpinning reputational value. And the safety-linked disaster at Massey certainly did knock with wind out of the company's reputational value.

We've seen this movie before -- most recently with Johnson and Johnson (see below). Here is how the National Association of Corporate Directors explains the current situation in their 31 May newsletter:

"The fate of a shareholder vote on Massey Energy's proposed $7.1 billion sale to rival coal producer Alpha Natural Resources is up to the state Supreme Court," the Washington Post (May 31) reports. The court is expected on Tuesday to take up the request by a trio institutional investors who are seeking to prevent a June 1 vote by Massey shareholders. The shareholders will also urge the court to seal case records. "The Charleston Gazette and National Public Radio are asking the court to open the files," the Post notes. "They argue the documents may shed light on the April 5, 2010, explosion at Massey’s Upper Big Branch mine that killed 29 miners." The investors state that the explosion and other actions damaged the company's value.

The
Wall Street Journal (May 31, Maher) adds that the court will decide whether to grant a temporary injunction sought by the investors, "who allege that Massey's board agreed to the sale to escape any personal liability for a coal-mining accident last year that killed 29 miners and drove down the company's stock price." The suit claims the company not only gave Alpha preferential treatment during the bidding process, it also failed to disclose key information about the negotiating process in its filings with the SEC. In addition, the Journal states, "The West Virginia suit alleges that the board failed to comply with a 2008 court order to institute new safety systems at the company." The plaintiffs include the California State Teachers' Retirement System.

Combined,
Benzinga (May 31, Wilcox) notes, "Alpha Natural and Massey would the be largest U.S. producer of metallurgical coal." Additionally, Massey is facing a separate suit brought by the New Jersey Building Laborers Pension Fund, which also seeks to halt the sale.

Here's the background as summarized recently in Intellectual Asset Management magazine, the official publication partner of the Society. According to Cathy Reese, a partner with law firm Fish & Richardson and chair of the Intangible Asset Finance Society’s Committee on Intangible Asset Governance, the Delaware Supreme Court’s 2006 opinion in Stone v Ritter adopted the concept of oversight liability, which had been discussed some 10 years earlier in the influential 1996 In re Caremark decision by the Delaware Court of Chancery. Importantly, this duty of oversight applies to all corporate assets, including intangible assets.

The court in Stone v Ritter stated that director oversight liability may be predicated on facts showing that either: “(a) the directors utterly failed to implement any reporting or information system or controls; or (b) having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention.”

Now the West Virginia Supreme Court gets to weigh in on the matter.

General Electric: Core concerns

C. HUYGENS - Thursday, March 24, 2011
The Financial Times is concerned that the nuclear crisis in Japan may adversely impact the reputation of General Electric (NYSE:GE).

According to the FT, GE designed the Mark 1 boiling water reactors (BWR) used at the Japanese plant, and supplied the No 1 and No 2 units that went into service in the early 1970s. It has also had engineers at the site up until last week; a team of 44 had been working on maintenance at the shut-down No 4 reactor when the earthquake hit. GE’s nuclear operations are now part of a joint venture with Hitachi of Japan that has two businesses: Hitachi GE Nuclear Energy, which is owned roughly 80-20 by the Japanese and US groups, and is based in Japan, and GE Hitachi, which has 60-40 US-Japanese ownership and covers the rest of the world.

Although the businesses are formally separate, they are closely linked. As well as the 70 people working on the crisis in North Carolina, they have a centre in Tokyo, near the Japanese government’s main response centre, to provide technical support and advice. You can read the balance of the FT article here.



Looking at the reputation metrics, GE’s ranking has been sliding as of late. The Steel City Re Corporate Reputation Index shows that after a steady rise, GE’s ranking shows a net drop over the trailing twelve months from the 60th percentile to the 50th percentile among its 86 peers of General Diversified companies. Consistent with the FT's concerns, the exponentially weighted moving average of the reputation ranking has been climbing lately and measured this past week at just above 6%.

The ten point slide in the Corporate Reputation Index has been associated with a trailing twelve week reputation velocity of -14% and a trailing twelve week reputation vector of -0.8%. Both, being signs of significant reputation volatility, reflect especially acute changes over the past week and suggest growing concerns about GE's reputation for design quality and safety excellence - key intangible assets in the nuclear reactor construction industry.

Now to bring this all back to finance. While GE has been outperforming its peers recently, as of 17 March, its return on equity over the trailing twelve months is only 2.3% greater than the median of its peer group. And it is trending negative.

Massey Energy: Reputation fire sale

C. HUYGENS - Thursday, February 03, 2011
The Wall Street proverb, “buy low...sell high” applies to many metrics. On 31 January, Alpha Natural Resources Inc. (NYSE:ANR) said it had reached a deal to buy rival coal company Massey Energy (NYSE:MEE) for $7.1 billion in cash and stock. The sale price was driven by expectations that 2011 will bring both high prices and high demand for the metallurgical coal produced by many Massey mines. That there was a sale at all was driven by mounting losses precipitated by last year's deadly explosion at Massey Energy's Upper Big Branch coal mine in West Virginia. And by Massey’s rock-bottom reputation.

In its final financial report for 2010, Massey said it suffered a net loss of $166.6 million last year. That's down from a $104.4 million profit in 2009, despite higher revenues in 2010. Close to 70 percent of last year's loss, or $115 million, were the result of costs associated with the Upper Big Branch disaster that killed 29 coal miners. The April explosion focused attention on the company's record of safety violations and drew intense scrutiny from federal mine safety regulators. Massey has cited the increased oversight, an ongoing mine disaster investigation and resulting production declines as reasons for its losses. The company also blamed its lower productivity on difficulty in finding enough mine workers.

In short, the reputational consequences of the catastrophic safety event have been costly -- in the last quarter of 2010 alone, the company's losses totaled $70.1 million. This is why. While firms with superior reputations outperform their peers, firms with damaged or poor reputations command lower prices and market share, have higher operating costs, pay more for credit, and have inferior vendor terms. And in heavily regulated industries, they have higher regulatory burdens.

The Steel City Re Corporate Reputation Index shows the precipitous fall in reputation ranking in April, a moderate rebound, and then a final collapse by the fall of 2010. The exponentially weighted moving average (EWMA) of reputation volatility peaked at 80% in October. And the equity value, reflecting the effects of the costs of the safety event, is giving investors an return on equity over the trailing twelve months that is underperforming the median of its peers by 14%.




The story continues. On 2 February, Massey Energy held a conference call with industry analysts. Among the key reputational message points were the comments by COO Chris Adkins that "voluntary quits" were up 12% in the 4th quarter over the same period last year; and from an operational perspective, Massey's labor shortage and increased federal regulation in response to the Upper Big Branch explosion account for a quarterly production shortfall of 300,000 tons.

And then there's the litigation related to reputation and its drivers: ethics, innovation, quality, safety, security and sustainability. In June 2010, a securities class action complaint charged the company with issuing false and misleading financial information to investors. The complaint alleges that Massey Energy claimed to be one of the safest coal mine operators in the industry, but in fact, safety at Massey Energy’s coal mines was allegedly sacrificed so that production goals could be met, and Massey had received undisclosed citations arising from uncorrected safety and other regulatory violations.

There's more. Shortly after the agreement was announced, a prominent plaintiff's law firm announced an investigation as to whether the 21% premium offered over the prior day's close, and accepted by the board, was consistent with the Board of Directors' duty to maximize value for Massey Energy investors.

Johnson & Johnson: Pining for antediluvian days

C. HUYGENS - Thursday, January 20, 2011
The past two years have witnessed a flood of bad news at the world’s largest diversified healthcare company, Johnson & Johnson (NYSE:JNJ). Ethical breaches, quality failures, and safety recalls by the bucketful, a few of which we noted previously. In more recent times, the Company has witnessed the inevitable pile on of regulators, and now--you guessed it--litigators.

On 17 December 2010, a shareholder group filed a lawsuit against the board as well as managers for an unspecified amount alleging failure to uphold their duty of oversight, breaching their duty of loyalty, and allowing adverse events to proceed which inevitably "destroyed the company's hard earned reputation." According to Tony Chapelle who participated in a recent Mission Intangible Monthly Briefing and who reports for the Financial Times' Agenda Week, “Governance experts say that J&J’s board should step in and more closely oversee the company’s business processes in three vital areas: quality, safety and ethics.” 

According to Cathy Reese who chairs the Society’s Governance Committee and who also participated in a recent Mission Intangible Monthly Briefing, lawsuits that claim a breach of the director duty of oversight warrant serious attention. That’s because in the 2006 case of Stone v. Ritter, the Delaware Supreme Court created a new directorial duty — the duty of oversight. In turn, the court said, directors who breach that duty have breached the duty of loyalty, for which they can be held personally liable.

The quantitative metrics point to both a loss of reputation and value. The first chart is based on the Steel City Re Corporate Reputation Index and reports reputation movement over the trailing 30 months. Beginning in mid 2009 (in red), the data disclose the slow decline of Johnson & Johnson’s reputation ranking relative to 78 peers comprising pharmaceutical sector companies valued at greater than $1B as of 6 Jan 2010.


The Company's relative decline is further accentuated by the overall decline of the industry's ranking. Shown in blue is the slow steady decline of the the average ranking of the 78-member pharmaceutical sector relative to approximately 9000 publicly traded companies on the main US and European exchanges.

There may be any number of explanations for the steady decline of the relative reputation of the pharmaceutical industry. One potential factor, according to Public Citizen, a consumer watchdog group that is no friend of the industry, is that the drug industry has now become the biggest defrauder of the federal government, as determined by payments it has made for violations of the False Claims Act (FCA). The drug industry has surpassed the defense industry, which had long been the leader. Public Citizen reports that of the 165 pharmaceutical industry settlements comprising $19.8 billion in penalties during the past 20 years, 73 percent of the settlements (121) and 75 percent of the dollar amount ($14.8 billion) have occurred during the past five years.

The economic consequences of the reputational decline appears to be an erosion in enterprise value. The chart below shows (in red) the slow decline of Johnson & Johnson’s relative return on equity compared to
 the average of 15 peers (in blue) comprising pharmaceutical sector companies valued at greater than $40B as of 6 Jan 2010. Also shown is the period return of the S&P500 Composite Index. During the 30 month window shown below, JNJ’s economic returns progressively decreased relative to its peers from outperforming them prior to mid 2009, to parity until mid 2010, to underperforming since then. The difference between the two sets of 30-month returns as of Jan 2011 is about 7% - coincidentally, the median cost of a headline risk event according to Steel City Re's research. The S&P500 returns over this 30 month period are essentially zero.


The ramifications extend internally. The National Association of Corporate Directors newsletter adds this morning that "Johnson & Johnson won't give eligible employees their full bonuses for 2010," according to the Wall Street Journal (Jan. 19, Rockoff). The Journal's sources explain the reasoning as "hits to the company's reputation and the 'mixed performance' for the year."

Rolls Royce: Wicking oily leaks

C. HUYGENS - Friday, December 10, 2010
Leaked information is rattling executives and politicians globally. But the literal elements of a leak stem from uncontainable fluids, and the adverse consequences can be more immediate. Rolls Royce (LON:RR) is facing just such a problem. Their Trent 900 engine, the power source for a number of airlines such as Quantas that fly the Airbus A380, appears to have a welding flaw in an oil pipe. The pipes are at risk of leaking, and the consequences of an oil leak include catastrophic engine failure. In reputation speak, this is a "safety" issue. In operations speak, this may be another example of a reputation risk arising from the supply chain. A quick word on Rolls Royce and their supply chain. As summarized by then chairman Sir Ralph Robins in 2000, "Seventy per cent of an engine's content is in the supply-chain and only 30% comes from in-house. We get all excited about cost-reduction in-house, but the supply chain is where it really counts."

According the the Financial Times, the current problem may cost the company up to $500m. According the to the Steel City Re Corporate Reputation Index metrics, the reputation cost is just beginning to manifest. The reputation index began the trailing twelve month period in the 63rd percentile and is currently in the 71st percentile relative to the 14 companies in the Aerospace and Defense peer group. However, the Index had been as of late in the low 80th percentile, and several dynamic metrics are providing indications of adverse value change: the exponentially weighted index moving average (EMWA) is up to 17%, and both the vector and velocity over the trailing twelve weeks are negative.

For the present, however, the equity returns over the trailing twelve months are equal to the median of the peer group, while the intangible asset fraction is below that of the peer group but equal to the mean of the S&P500 Index constituent members. Look to IAM magazine issue 46, due in March 2011,  for an extended examination of this Company from an intangible asset, risk, and reputation management perspective.


BP: Oh no, not again

Nir Kossovsky - Monday, May 03, 2010
In Douglas Adams’ The Hitchhiker's Guide to the Galaxy, “the only thing that went through the mind of the bowl of petunias as it fell was 'Oh no, not again.' Many people have speculated that if we knew exactly why the bowl of petunias had thought that we would know a lot more about the nature of the Universe than we do now.”



We can reasonably assume that similar thoughts raced through the minds of BP (NYSE:BP) executives on 20 April as the Deepwater Horizon drilling rig exploded, caught fire, and sank. And while we are probably equally clueless about the nature of the Company, as are stakeholders who own its reputation, of this we can be certain: it is sinking.

As illustrated in the series of Steel City Re Corporate Reputation Index charts below, BP and the other firms associated with this safety and environmental disaster are experiencing an acceleration of a steady reputational decline. And as noted in the book, Mission Intangible and more recently in an article in CFO magazine, these declines are indications and warnings of an increased risk of a reputational event.

Not that BP is unaware. The New York Times quotes BP CEO Tony Hayward on Friday as saying, “Reputationally, and in every other way, we will be judged by the quality, intensity, speed and efficacy of our response.”

BP has blamed the rig’s owner and operator, Transocean (NYSE:RIG), for the accident. Further investigation is now suggesting that a drilling subcontractor, Halliburton (NYSE:HAL), may have failed to execute a critical task that prevents gas and oil from escaping from the well.

The process is called ‘cementing’ and it is challenging. A 2007 study by the U.S. Minerals Management Service found that cementing was the single most-important factor in 18 of 39 well blowouts in the Gulf of Mexico over a 14-year period. More recently, Halliburton (NYSE:HAL) has been accused of performing a poor cement job in the case of a major blowout in the Timor Sea off Australia last August. An investigation is under way.

As a case study of risk and reputation management, this has almost all the main elements. Consider the following:

1. Iconic brand, BP, working through subcontractors - a key source of risk (we explore this topic further this Friday, see below)
2. History of failures in managing the processes of assuring safety - a reputation lacking resilience 
3. Marketing campaign built around sustainability laid to waste by a massive oil spill - lack of authenticity

The LA Times notes in a story on 1 May that experts were cautious about attributing blame, pending what are expected to be lengthy investigations by Congress and the Department of Homeland Security, which oversees the Coast Guard.

Satisfy your intellectual curiosity!

If the above issues pique your interest, here are several things you can do right now:

1. Register free of charge for the next IAFS Mission Intangible Monthly Briefing set for Friday 7 May at 12h00 EDT. The conversation will feature Scott Childers from Walt Disney and Bob Rittereiser from Zhi Verden on “Process-driven reputation risk in supply chains”
2. Purchase the book, Mission: Intangible. Managing risk and reputation to create enterprise value, at the IAFS Store (or any online book retailer) 
3. Become a member of the Intangible Asset Finance Society.
4. Join our community on Linked-In.

Disney: Holistic supply chain management

Nir Kossovsky - Thursday, April 29, 2010
Next Friday, May 7, the Society's monthly Mission Intangible Monthly Briefing will feature Scott Childers from the Walt Disney Company (NYSE:DIS) who is calling for holistic supply chain vendor management, and Bob Rittereiser from Zhi Verden whose Global Trademaster™ product provides total supply chain visibility. A note this past Monday in the Wall Street Journal explains why this is so important.

On Monday U.S. Federal, state and local law enforcement officials, part of the National Intellectual Property Rights Coordination Center said they made their biggest-ever seizures of counterfeit goods this month in two operations that netted more than $240 million in a sweep of more than 30 U.S. cities. Immigration and Customs Enforcement announced the double-barreled operation on Monday to coincide with World Intellectual Property Day.

Commemorating a day to heighten awareness of intellectual property with arrests may not be festive, but it is appropriate. Fake goods do more than rob intellectual property owners of revenue. Fake goods raise the specter of a full range of reputation-linked issues that go beyond cash flow to create risk in areas as  diverse as ethics (international labor standards), quality, safety, security, and sustainability. The article further notes that next week, the Naval Criminal Investigative Service and the Defense Criminal Investigative Service will begin targeting counterfeit goods that could get into the military supply chain. The U.S. General Services Administration will target fake goods in the federal civilian supply chain.

To target effectively, one needs intelligence. According to Mr. Rittereiser, Zhi Verden’s Global Trademaster™ provides that intelligence; according to Mr. Childers, having that intelligence is a necessary component for world class supply chain management.

Act on your intellectual curiosity!

If the above issues pique your interest, here are several things you can do right now:

1. Register free of charge for the next IAFS Mission Intangible Monthly Briefing set for Friday 7 May at 12h00 EDT. The conversation will feature Scott Childers from Walt Disney and Bob Rittereiser from Zhi Verden on “Process-driven reputation risk in supply chains”
2. Purchase the book, Mission: Intangible. Managing risk and reputation to create enterprise value, at the IAFS Store (or any online book retailer) 
3. Become a member of the Intangible Asset Finance Society.
4. Join our community on Linked-In.

Massey: Mining mess

Nir Kossovsky - Wednesday, April 14, 2010
On 5 April 2010, an explosion in a West Virginia coal mine owned by Massey Energy (NYSE:MEE) killed 29 miners and propelled the incident into the worst US mine disaster since 1970. USA Today reports that since 2008, the mine operator was cited more than 700 times by the Mine Safety and Health Administration for dangerous conditions arising from inadequate air, faulty fire extinguishers, exposed wiring, malfunctioning communication systems, inaccurate gas monitors, and deep pools of standing water. Massey counsel Shane Harvey conceded that the Upper Big Branch River "mine's record was not as good as Massey's record as a whole."

Without in anyway wishing to diminish the seriousness of the tragedy, and in keeping with the Society's goal of advancing superior intangible asset management, we asked if there were financially relevant reputation metrics that might help build the business case for fostering better safety practices. The subtext of the question, which was overtly asked of both Jon Low of Predictiv and Paul Liebman of Dell at the Mission Intangible Monthly Briefing Friday 9 April is this: in an industry with a sullied reputation, can a tragedy like this diminish reputation any further?

Turning to the numbers, we see from the 12 trailing month's graph of the return on equity from bigcharts.com that Massey Energy has rewarded shareholders handsomely since the low point of the market collapse in the spring of 2009. While return on equity as of early April was nearly 300%, the event did trigger a substantial sell off and knocked about 18% off the market capitalization. (Shown in brown is the 45 day exponentially weighted moving average.) 



Now turning to the Steel City Re Corporate Reputation Index spanning the period from 8 Dec 2008, we see the values for 7 April 2010 (shown in red) represent a significant change in the trend for the prior 16 months. The chart below suggests that stakeholders do care when matters rise to the level where they create headline risks. So it seems that headline risk avoidance may be one means of fostering better conformance with safety practices.

Art assurance: Monetizing murals

Nir Kossovsky - Tuesday, March 30, 2010
In the Roman arch of intangible assets, safety is a central driver of reputation value in the transportation sector. Hence the air travel aphorism, “any landing you walk away from is a safe landing.” Which does little to aid the prospective buyer of transportation services.

Fortunately, in western countries, we have government agencies that provide certificates affirming minimum safety requirements. We have insurers demanding affirmation of safety practices.

Pity the buyer of transportation in less developed nations. Like Haiti. In a market lacking regulatory standards, a reputation for safety makes or breaks a transportation business.

Now appreciate the ingenuity of free markets. In Haiti, bus operators use intangible assets – murals -- to signal the value of the vital intangible asset – safety. In a story today on National Public Radio, Adam Davidson explains that a bus painted with bright colorful murals – a material investment – signals to potential patrons that the owner expects the vehicle to be viable for some time. The inference is that the owner’s considerable investment in art is matched by a considerable investment in protecting that art through superior vehicular maintenance.

Fine bus art is merely a means of establishing a reputation for safety, and one more extra-financial strategy for signaling value.

Whistling by the graveyard

Nir Kossovsky - Monday, March 01, 2010
It is significant that there is little public gloating from other auto manufacturers as Toyota Motors’ (NYSE:TM) leadership globally offers mea culpas. Although it is Toyota’s reputation that is melting under the heat of headline risk, competitors are only too aware that the next tolling of the bell could be for them.

This is why. While the damaged intangible assets are three of the big six: ethics, safety, and quality, the underlying problem is the global supply chain. According to Bob Rittereiser, CEO of Zhi Verden, a supply chain systems and information management company, “the stark reality today is that the global supply chain is a business operating system with global reach, thousands of participants, established practices, government requirements, blazed paths, known bottlenecks and many known risks, yet no one is in charge!” Or, said differently by John Hurrell, Chief Executive, Association of Insurance and Risk Managers, “The complexity of supply chains puts your reputation in the hands of the lowest common denominator.”

Reputation drives intangible asset value. As reported in Mission: Intangible -- Managing Risk and Reputation to Create Enterprise Value (IAFS with Trafford Press, March 2010), research shows that superior reputations pay off with (i) pricing power , (ii) lower operating costs, (iii) greater earnings multiples, (iv) lower beta (i.e., stock price volatility) and (v) lower credit costs. And when reputation is damaged, these benefits are lost. All told, we estimate the reputational impact, so far, to be a $2 billion cost to Toyota's earnings and a $25 billion cost to its market capitalization.

Previously we shared Toyota's reputation metrics from the Steel City Re Corporate Reputation Index. We take time out from our membership drive to offer this financial breakdown shown at left.

Legend. Income Statement Impact (values in $‘000). Lost sales and a 3% loss in pricing power will reduce Toyota’s gross profit by around $900 million. Costs associated with the worldwide recalls, litigation, insurance subrogation, and regulatory compliance will cost at least another $500 million. The lower credit ratings will increase borrowing costs by at least another $71 million, and non-cash depreciation expenses associated with a 3% write down of Toyota’s automobile asset base will reduce earnings by another $540 million. Data source: Steel City Re.

Join Us

If the above intrigues you, frightens you, or challenges you to learn more, look no further. The Intangible Asset Finance Society wants to be your business resource. Join us and be part of an organization that provides a wealth of educational materials to further your executive career.

Innovation: Hot Policy and Practice Issues

Be sure, by the way, to register for a complimentary seat at the 5 March Mission:Intangible Monthly Briefing, held by phone at 12h00, EST. It's an innovation smack down. Athena Alliance President and intangible asset policy expert Kenan Jarboe goes head to head with Steel City Re's Judith Giordan, Managing Director of IA Finance and former senior technology executive with Pepsi, Henkel, International Flavors & Fragrances, and Polaroid. Yes, as always, registration is complimentary and slides are already posted on the website events page.

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