IP Management Case Studies

Crystal Lake

A Sydney family established Crystal Lake Beverages Pty Limited ('Crystal Lakes') in 1973 to manufacture carbonated beverages. Crystal Lake has developed to become a leading producer of 'soft drink' beverages in Australia. The soft drink beverage market is built largely on the basis of customer impulse and brand recognition. Crystal Lake has established a strong reputation and well-recognised brand name and has a market share by value, which is almost double its nearest competitor brand.

In June 2001, Prescott Foods Limited ('Prescott'), a listed Australian company, acquired all of the issued capital of Crystal Lake for $330 million. As at the acquisition date, Crystal Lake had net tangible assets of $35 million. As a result, the total value of intangible assets acquired by Prescott was equal to $295 million.

When an entity or operation is acquired, the cost of the underlying identifiable intangible assets are measured at the acquisition date at their fair values according to AASB 1015. Under current Australian accounting standards, all the excess of the cost of acquisition incurred by Prescott over the fair value of the identifiable net assets acquired would be attributed to goodwill. AASB 1013 requires that any recognised goodwill should be amortised on a straight-line basis over its expected useful life, which cannot exceed 20 years. Amortising the goodwill incurred in this transaction over a period of twenty years would lead to an increase of Prescott's amortisation expenses of $15 million, and reduce Prescott's recorded net profit after tax by an equivalent amount.

However, under AASB1021, if this value is allocated to an identifiable intangible asset that is considered to have an indeterminable useful life, then that identifiable intangible asset will not be required to be amortised. Judgement is required to determine what identifiable intangible assets exist and whether they can be measured with sufficient reliability.

Prescott requested an independent valuer (the 'Independent Valuer') to prepare an assessment of value of the Crystal Lake brand upon acquisition to assist in the allocation of fair value between identifiable and unidentifiable intangible assets. For these purposes, the brand name and registered trademarks were identified as separable intangible assets.

The valuation methodology that the Independent Valuer selected was the relief from royalty methodology. This was considered most appropriate, given the type of intangible asset being valued and the type and extent of information at the Independent Valuer's disposal.

After review of Crystal Lake's historical sales, as well as its forecast sales under Prescott's ownership, Crystal Lake's future maintainable sales was assessed based primarily on the forecast sales achievable for the Crystal Lake brand under Prescott's ownership. The Independent Valuer selected $350 million as an estimate for future maintainable sales.

The determination of an appropriate notional royalty rate was based on industry sources and licencing databases indicating that royalty rates in the food and beverage industry for long term licencing arrangements were in the range of 4 percent to 8 percent. This was adjusted to take into account Crystal Lakes specific brand circumstances including:

• The high profitability of the Crystal Lake brand, based on forecast gross margin and EBIT for the valuation period, and the level of royalty justifiable based on this profitability;
• The rate of return that would be required by a licensor relative to the rate of return required by a licensee; and
• The strong position in the market of the Crystal Lake brand, including the brand's volumes, degree of penetration of products, quality of packaging, effectiveness of distribution network, the length of time that the brand has been in existence and extent of brand recognition.

On the basis of the above factors, the Independent Valuer utilised a royalty rate of 7 percent in valuing the Crystal Lake brand name and registered trademarks resulting in a gross royalty amount of $25 million.

The Independent Valuer also allowed for expenses likely to be incurred in retaining ownership of the Crystal Lake brand and administering the royalty stream under the notional licensor/licensee scenario. These expenses include trademark registration, legal expenses, quality control and general administration. The Independent Valuer used a factor of 8 percent of gross royalty income to reflect such costs resulting in costs of $2 million.

The final step in determining value was that this imputed royalty stream of $23 million, which is before both interest and tax, had to be capitalised. In determining appropriate capitalisation multiples, the Independent Valuer had regard to earnings multiples of listed companies in the food and beverage sectors, earnings multiples implicit in the acquisition of Crystal Lake by Prescott and adjustments to reflect the risks associated with brand royalty cash flows, as well as other factors.

On the basis of the above issues, the Independent Valuer selected a capitalisation multiple range of 11 to 12 times resulting in a value of between $253 million and $276 million.

The Independent Valuer considered the above range in light of the difference between the purchase price paid by Prescott for Crystal Lake and the net tangible assets acquired. The total assessed value of the Crystal Lake brand name and registered trademarks was $265 million (midpoint of the assessed value range). This was around 90 percent of the intangible value on acquisition. The residual goodwill was equal to $30 million.

The allocation of acquisition consideration to brand name and registered trademarks value resulted in a reduction in annual amortisation expense from $15 million down to $2 million contributing to an equivalent increase in Prescott's recorded net profit after tax.