Disruptive tech valuation

Despite corporate preoccupation with the risks and opportunities posed by disruptive technology, many investors struggle to differentiate between blockbuster tech and wishful thinking. The results? Squandered investment opportunities. Overpayments and impairments. Promising IP withering on the vine. Erosion of competitive advantage. Share price fluctuations. Occasional big wins.

Why do many valuations of potentially disruptive technology get it wrong? Because insightful tech valuations need to consider a multi-disciplinary range of questions:

• Is the tech functionally superior to alternatives?
• How well are the differentiating features protected?
• Can functional benefits be translated into economic benefits?
• What is the probability of success of the R&D process?
• What is the extent of commercialisation barriers?
• How attractive is the addressable market?
• What risk results from the rate of tech evolution, uncertainties regarding IP protection, and unproven market performance?

Each question unfolds into deeper layers. Answers require multi-disciplinary inputs, including technical expertise, corporate finance expertise and IP expertise. All require interpretation within the market landscape.

One response to this complexity is blinkered use of valuation models that ignore the technical and legal complexities of tech assets. Another response is to use the complexity to justify qualitative investment decisions. I’m not a fan of ‘one-eyed’ or ‘eyes-closed’ estimates of tech value. The risk of bad decisions is too high. A preferable approach is to use a 360˚ assessment of the tech as the platform for a valuation. This does not eradicate uncertainty, but provides better visibility of the building blocks of value.

Deloitte’s Tech Rating provides a multi-disciplinary assessment of the earnings potential and risk profile of tech assets. Over forty sub-measures shine a light on:

Functional tech benefits: Although obviously the starting point of the value equation, it can be difficult to gauge utility relative to alternative technologies. Our rating process uses a variety of data sources to assess utility, linkURL tech features to performance and decouple the impact of contributory assets.

Financial characteristics: The rating process evaluates the expected impact of the technology on revenue, margins and capital expenditure. Calibration reflects characteristics such as the scalability, and the non-linear relationship between changes in utility and value.

Protection: Unless the differentiating features of a technology are protected, its competitive advantage will rapidly be eroded by free loaders. The rating process includes an assessment of patents, trade secrets and other forms of protection. Here is a flavour of IP complexities:

• Even after grant, patents provide little commercial advantage if the claims don’t cover important dimensions of the technology, or if they are easy to design around, or hard to enforce. In contrast, strong patents provide monopoly rights to important tech features
• Protection of trade secrets is compromised if controls don’t prevent inadvertent disclosure, or if contracts don’t adequately protect against disclosure by employees and suppliers
• In the context of software, copyright protects the expression of the work, not the underlying idea or process.

Market opportunity: In addition to its intrinsic quality, the value of technology is contingent on the characteristics of the markets in which it is used. The Tech Rating integrates market, financial, licensing and patent data to measure market attractiveness.

Development risk and commercialisation barriers: Early-stage promise can be eroded or amplified during the R&D journey. Once developed, the ability to successfully commercialise technology can be heavily reliant to having access to manufacturing, distribution or customer assets. Sub-measures of the Tech Rating estimate time to market and probability of success.

Earnings uncertainty: Tech utility and commercialisation strategy drive market penetration, price and costs. We assess levels of uncertainty with reference to historic results, market research and tech benchmarking.

Asset specific risks: This gauges the tech’s susceptibility to obsolescence, infringement of third party IP, and challenges to the validity of its own IP.

Finding the right blend of measures and data sources has been tough. But the good news is that our rating process integrates relevant data sources into a streamlined model that provides robust and repeatable outputs. Not a magical, single-measure investment opinion, but a coherent snapshot of the earnings potential and risk profile of tech assets.

The Deloitte Tech Rating brings an old fashioned ‘kicking the tyres’ approach into the era of IP assets, providing:

• a foundation for insightful tech valuations
• a crucial due diligence perspective for tech-centric transactions
• a framework for tech strategy and risk management.

The Tech Rating is part of Deloitte’s IP Advantage capability.