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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Heartland: IT tales

Nir Kossovsky - Thursday, January 07, 2010
About one year ago, Heartland Payments Systems (NYSE:HPY) reported a record-breaking security breach. We reported previously on this event and its economic consequences. In today's note, we look quantitatively at the reputation effects of this breach and contrast them with two of Heartland's customers, Mastercard (NYSE:MA) and Visa (NYSE:V), who sued Heartland for damages. The intangible asset financial management point we wish to make is that there are useful financial metrics to help executives manage risk and reputation to create value from their intangible assets.

Let's begin with the Steel City Re Corporate Reputation Index. The fall in Heartland's reputation in January 2009 exhibits the typical cliff effect associated with events that speak to the heart of a company's intangible asset value -- in Heartland's case, data security. Contrast Heartland's reputation with Mastercard, a firm whose Steel City Re Reputation Index standing is pegged at the 100th percentile for most of the past year. Not surprising, Mastercard rewarded its stakeholders during this period with an above average 76% return on equity relative to both the S&P 500 index (20%) and the median return of the 72 companies in the IT Services sector (60%). Visa, with a public offering less than 2 years old, shows a climbing reputation index with values in the high 90's percentile, but its return is slightly less that the median of its peers. We'll call this less than above average performance the results of the hangover from Visa's IPO.



Let's look quickly at the book values. Heartland booked its loss in intangible asset value at the end of March, about 10 weeks after the equity markets panicked. Its intangible asset value dropped from around 100% of enterprise value to 70%, but has been climbing since. In contrast, Mastercard's intangible asset value has been climbing steadily to the 100% mark, while Visa showed some volatility over the year and ended up in the mid 90's.



Recovering from the breach

Nir Kossovsky - Thursday, November 19, 2009
Today’s MISSION:INTANGIBLE note was prompted by my colleague Robert Liscouski, COO with Steel City Re and a former Assistant Secretary in the Department of Homeland Security. Bob is yielding his IAFS position to the incoming Chair of the Security Committee, Scott Childers from The Walt Disney Company.

To my query of what is hot in security business processes and reputation that will interest our IAFS members, Bob said this: data security. This is why. The new poster child for data security is Heartland Payment Systems, (NYSE:HPY). Heartland, the sixth-largest payments processor of credit and debit card transactions in the U.S., announced in January that its records were hacked. A recently apprehended cyber-gang, according to the Justice Department, compromised 130 million Heartland accounts.

What are the lessons of interest for IAFS members? There are two lessons covering, respectively, the costs of reputation loss and the potential for reputation restoration.

The first lesson is that this was an expensive breach with growing costs. Heartland reported in May that the breach had cost it $12. 6 million so far, which included legal costs and fines from Visa and MasterCard, who said the company was not compliant with payment-card–industry rules. Then, In filings for the Securities and Exchange Commission, Heartland said the 2008 data security breach cost it $32 million as of June 30. Most recently, as of 30 Sept in the 10-Q filing, the Company recorded pre-tax expenses of $105.3 million or about $1.74 per share, associated with the security breach, aka, the Processing System Intrusion.

The majority of these charges, or approximately $90.8 million, related to: (i) assessments imposed in April 2009 by MasterCard and VISA against us and our sponsor banks, (ii) settlement offers we made to certain card brands in an attempt to resolve certain of the claims asserted against our sponsor banks (who have asserted rights to indemnification from us pursuant to our agreements with them), and (iii) expected costs of settling with certain claimants with whom settlement discussions are underway.

There is more. The Heartland breach – which has so far resulted in 28 class-action lawsuits filed against the company precipitated a near-immediate 50 percent drop in Heartland's share price (shown in red). Total equity value lost, rebased against the S&P500 Index (shown in blue) as of today, is about $300 million. Data source: Big Charts.com.



The second lesson is that following its near-death experience, Heartland is now committed to building reputation resilience by establishing the new standard for data security processes. Heartland is raising the bar in retail payments security by bringing end-to-end encryption to its network. It will be expensive and a big logistical challenge to execute. However, as long as it's accompanied by good policy and process, Heartland's encryption initiative will plug a definite security gap in the payments system.

In turning to processes to cure the defects that led to the reputation loss, and by creating a new standard for best practices, Heartland is following the model established by Johnson and Johnson with their product security issue, and El-Al Israel Airlines with their hijacking-related security issues. It is a best practice that examplifies the values of the IAFS and its members. Won't you consider joining us?

Heads up: IAM magazine, the official publication partner of the Society, will feature a reputation-focused case study on Johnnson & Johnson (NYSE:JNJ) in the January 2010 issue, #40.

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