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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RR Donnelley: Google it

C. HUYGENS - Wednesday, October 31, 2012
As the saying goes, there are only two types of companies: those that have had operational failures, and those that will. On 18 October, RR Donnelley & Sons, the printing-services firm, released the 8K quarterly earnings report for Google, the internet services company, 4 hours earlier than expected. The markets closed with the S&P500 down 0.24%, RR Donnelley down 0.88%, and Google down 8.00%.

This is how the Wall Street Journal’s MarketBeat blog reported the story, excerpted. First, Google’s take on the matter:

Earlier this morning RR Donnelley, the financial printer, informed us that they had filed our draft 8K earnings statement without authorization. We have ceased trading on Nasdaq while we work to finalize the document. Once it’s finalized we will release our earnings, resume trading on NASDAQ and hold our earnings call as normal at 1:30 PM PT.

Now, Donnelly’s take:

We are fully engaged in an investigation to determine how this event took place and are pursuing our first obligation – which is to serve our valued customer.

The value of that service is now being questioned. As reported in the New York Times blog, Dealbook:

An executive at Webfilings, a company based in Ames, Iowa, that sells an application that allows companies to self-file, used last week’s events as a marketing opportunity, reminding customers that “this unnecessary mistake reinforces the need for public companies to completely control the release of their financial data,” as Mike Sellberg wrote on the Webfilings blog.

The reputational risk for Donnelley is security--one of the six pillars of reputational value. As Chuck Malloy from Intel told Dealbook, “We own the liability and the risk, and this allows us to maintain the integrity of the reporting process. If there’s a problem, it’s our problem.”

The reputational value metrics from Steel City Re do not indicate that the operational failure has matured into a reputational crisis (7% drop in market cap, massive media attention, regulatory approbrium, etc.), but the event is nevertheless impacting Donnelley's reputation adversely. Looking first at the Vital Signs, (Column 2 Row 2 below), the current RVM volatility is only slightly higher than the historic volatility, both below the median at the 17th to 19th percentile. The company’s reputational rank is the 33rd percentile, ROE at the 13th percentile, and forecast stability is below the median. Basically, the quick view is that baseline expectations among stakeholders are low.

Indications that stakeholders as a group do not expect the incident to be critical, but recognize that no good will come out of it, are reflected in the three volatility measures (Column 1 Rows 2-4, and Column 2 Row 4). All show low levels of volatility for both CRR, a measure of reputation rank, and RVM, a non-financial measure of reputational value. The volatility, which is indifferent to overall market risk (VIX), is leading to a further loss in  both reputational value and reputation ranking relative to peers. Add to that the company's drop in  equity value, and you have near-universal concurrence among stakeholders: thumbs down.

McGraw Hill: Rating the rater

C. HUYGENS - Friday, August 12, 2011
It’s been a heady week for Standard & Poor’s, the rating agency that is a division of McGraw Hills Companies (NYSE:MHP). All that publishing work -- known in the industry as practicing first amendment rights to opine on the credit rating of both sovereigns and companies -- has evoked a not insubstantial amount of press attention. This is not necessarily good. Former EF Hutton CEO Robert Rittereiser, an authority on financial turnarounds and reputational crises notes, "On Wall Street, the probability of an entity retaining its wealth is inversely proportionate to the amount of coverage it receives in the Wall Street Journal."

Turning the the sources of this week's press attention, in the event that you have just been let out of jail or have moved to the planet earth from elsewhere, scores of companies and entities saw their credit ratings hit Monday after S&P downgraded the United States. Interesting, reports AFP (Aug. 8), the ratings agency did not downgrade commercial banks, especially the four largest seen as resting on the implicit "too big to fail" policies of the government. As the impact of its cut of the US rating from triple-A to AA+ began to hit markets, S&P announced that numerous government-related enterprises like Fannie Mae and Freddie Mac were likewise downgraded because they depend on the government's guarantee of their own bonds. Seventy-three investment funds -- fixed-income funds, exchange-traded funds, hedge funds, and others -- were downgraded, 70 of them by two notches, because they each had "significant exposure" to U.S. government debt. Ten insurance companies were hit, five with downgrades to AA+, including TIAA, USAA, and Northwestern Mutual, for their huge holdings of Treasury securities. Five others, including Berkshire Hathaway, the investment vehicle of billionaire Warren Buffett, kept their AAA ratings but were given negative outlooks.

The value-sapping blow back began shortly thereafter as many critics began to express doubt over the value proposition underlying S&P's core business model. "Credit ratings are becoming irrelevant in a bond market where investors still perceive AAA companies from Johnson & Johnson to Microsoft Corp. to be a higher risk than recently downgraded U.S. Treasuries," reports Bloomberg (Aug. 11, Detrixhe, Faux). After the U.S. was downgraded to an AA+ rating by Standard and Poor's, the extra yield investors demand to own bonds issued by top-rated companies versus Treasuries reached 0.81 percentage point, the most since July 2010, according to Bank of America Merrill Lynch index data. The wider spread suggests that investors still believe the highly-rated companies are a bigger credit risk.

There's more. As we have often noted, the real effects of a reputational crisis become apparent when regulators take interest. As evidence that the full "pile on of regulators, litigators and mommy bloggers" has set on Standard & Poor's, the SEC reportedly has asked the credit rating agency to disclose who within its ranks knew of its decision to downgrade US debt before it was announced last week, as part of a preliminary look into potential insider trading, the Financial Times (Aug. 12, Scannell) reports. The inquiry was said to have been made by the SEC's examination staff, which has oversight of credit rating firms. The exam staff can make referrals to the SEC's enforcement division if it believes any laws have been violated, but the inquiry might not result in a referral. Proving someone leaked information about the downgrade, or traded ahead of it, could be challenging. Many traders anticipated the downgrade and bets could occur across numerous securities or currencies without inside information.

S&P's reputation was tarnished during the great crash of 2008 when it became apparent that many of the complex structured products it had rated as AAA were much riskier. That story, as you know, has not yet played out fully. The numbers suggest that S&P's reputation was making a comeback until recently. According to the Steel City Re Corporate Reputation Index, McGraw Hills Co's ranking twelve months ago ranked in the 25th percentile among a peer group of 12 companies in the publishing/services business. That ranking peaked at the 60th percentile, only to drop over the past few weeks to the 36th percentile.

The company's exponentially weighted moving average ranking volatility peaked at almost 200%; its downward curve was arrested this past week as both the velocity and vector affirmed negative trends of -18% and -3.9% respectively.

The company's current return on equity (ROE) over the trailing twelve months is 25%. That is unlikely to persist as the reputational volatility grows for the reasons discussed above. On the basis of reputational metrics alone, this is not a stock to own. Expect a takeover with managerial overhaul -- a strategy that many wish would be realized by News Corporation, too.

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