The changing world of appraisals: globalization has had a major impact on appraisals, and so has the internet and the growing use of intellectual property as collateral. Borrowers need to be aware of these changes.
Over the past several years, driven by the economy and increased globalization, the appraisal industry has changed significantly. How assets are sold and who is buying them are two of the most significant changes. The Internet and the growing use of intellectual property as collateral have also had an impact on deal structures and asset disposition recoveries. Lenders and borrowers need to be aware of these changes, which have substantially influenced the appraised value of inventory, equipment and other assets used to secure debt.
Inventory Sell-through Brings Greater Recovery
Advance rates for asset-based lending deals historically were based on the forced liquidation value of the borrower's inventory--how much the inventory would bring if it were sold in bulk to wholesalers, competitors or liquidators. Today, advance rates are typically based on a percentage of the net orderly liquidation value (NOLV).
NOLV represents the gross orderly liquidation value recovery, less any expenses associated with the disposition. Rather than liquidating as much of the inventory as possible in bulk--at perhaps 40 to 50 percent of cost--most inventory appraisal companies attempt to sell some portion of the goods to the borrower's regular customers over a period of time.
This "sell-through" method typically produces a much higher gross recovery than a bulk sale, since a portion of the finished goods are sold at a higher percentage of cost and, in some cases, at a profit margin.
Expenses are much higher in a sell-through model versus a bulk sale, because of the costs associated with running the sale for a longer period. However, since finished goods are worth more to the borrower's normal customers, an inventory sell-through drives a much higher NOLV even after deducting the higher expenses. As a result, the sell-through approach has dramatically changed the way inventory is ultimately valued.
Used Equipment Market Challenged
With the sizable migration of manufacturing facilities to less expensive foreign locations, a higher percentage of used manufacturing equipment is being marketed outside the U.S. In the U.S., buyers for late-model equipment still can be found, but often, only foreign buyers are interested in older equipment.
One industry hit particularly hard by this trend is textiles. Within the past five years, hundreds of U.S. manufacturing facilities shut down as the apparel industry relocated to Mexico, Pakistan, India, China, Bangladesh and Sri Lanka. Carpeting is one of the few categories within textiles where manufacturing remains primarily in the U.S., because shipping costs make it hard for foreign manufacturers to compete. For most other textile machinery, the U.S. market has softened considerably. Textile dealers are spending a substantial amount of time cultivating relationships with foreign buyers and brokers.
China also has been a major force in the overseas movement. It drove steel prices through the roof by buying scrap metal in any form from around the world, melting it, reusing it and ultimately selling many finished goods back to the U.S. China's legal and financial systems also have evolved, and the country has succeeded in attracting more venture capital, leading to state-of-the-art manufacturing facilities and technological advances.
The shift to overseas equipment sales has required appraisers and dealers to broaden their connections within other countries and expand their knowledge of government regulations and tax laws. In order to accurately value machinery and equipment, appraisers must have experience dealing with several different countries, and have a strong relationship with the equipment dealers most familiar with supply and demand issues in those countries.
The international equipment market's growth is a bit of a Catch-22. If the Third World manufacturing economy didn't exist, the U.S. market for both goods and equipment would be stronger. Worldwide competition for goods doesn't help U.S. producers, but it does create a place to sell equipment.
Impact of the Electronic Marketplace
The Internet has played a significant role in the expansion of overseas equipment sales. Because of its global reach and ease of use, it connects sellers with interested buyers much more quickly than traditional approaches, and is especially valuable in the disposition of specialized equipment.
Increasingly, the Web is being used as a vehicle for both advertising and conducting live auctions. By reaching a wider audience of potential buyers, some would argue that webcast auctions have narrowed the gap between the auction value and the orderly liquidation value. Most major liquidation companies send regular emails that identify equipment for sale and announce public auctions.
This additional exposure to the marketplace almost certainly has increased recoveries for used equipment sales. For inventory, the Internet has given appraisers the ability to analyze and sort data to identify which SKUs (stock-keeping units) are moving slowly or are obsolete, improving the speed and accuracy of valuations.
Growing Use of Intellectual Property
While asset-based lenders historically have relied on tangible assets, there has been a growing interest in using intangibles or intellectual property such as brand names, trademarks and patents as collateral. Given the current availability of credit and in this borrower's market, asset-based lenders may include a larger percentage of intangible assets in the collateral pool. This doesn't necessarily increase the lender's risk exposure if the value of the intangible is carefully appraised.
Approaches for appraising intangibles typically are based on some form of discounted cash flow. For example, to value a trade name, the most common approach is the relief-from-royalty method. It considers how much revenue a company could generate by licensing a trade name that it owns. Licensed trade names that generate royalty streams can be valued very accurately. For brands that aren't currently licensed, comparable licensing agreements can be used to estimate the royalty rate a given brand should command in the current market.
Intellectual properties, such as brand names, can have a significant impact on recoveries in the event of liquidation. Although intangible valuations need to be reviewed carefully when being eyed as collateral support, tangible fixed assets may actually be harder to sell. For established brand names, real value can be justified because revenue can be generated through licensing agreements.
Getting It Right
Asset valuation, whether tangible or intangible, is a highly complex process that's part art, part science. Developing an accurate valuation requires tapping into the expertise and knowledge of appraisers with experience in a specific asset class, as well as a particular industry. A lender looking to underwrite an aluminum die-caster, for instance, may need the opinions of both the die-casting machinery expert and someone who is well versed in aluminum inventory.
As globalization and changing economies continue to affect the marketability of collateral, it's critical that changes are factored into the process of determining its ultimate value.
Robert Maroney is Senior Vice President and Chief Appraisal Officer with Bank of America Business Capital. He can be reached at 781.944.4226 or firstname.lastname@example.org.
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|Date:||Jan 1, 2005|
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