The Value of a Brand Name

From Net Income to Operating Income and Equity to Value

The profits margins for firms can be stated in terms of net income (as they have in all the examples so far) or in terms of operating income (EBIT). If pre-tax operating margins are used, the appropriate value estimate is that of the firm. In particular, if one makes the assumption that

Free Cash Flow to the Firm = EBIT (1 - tax rate): Net Capital exp. and working capital needs are zero.

Then the Value of the Firm can be written as a function of the after-tax operating margin= (EBIT (1-t)/Sales

where,

g = Growth rate in after-tax operating income for the first n years

gn = Growth rate in after-tax operating income after n years forever (Stable growth rate)

WACC = Weighted average cost of capital

The value of a brand name

• One of the critiques of valuation is that is fails to consider the value of brand names and other intangibles.
• The approaches used by analysts to value brand names are often ad-hoc and may significantly overstate or understate their value. Firms with well known brand names often sell for higher multiples than lesser-known firms. The standard practice of adding on a 'brand name premium', often set arbitrarily, to discounted cashflow value, can lead to erroneous estimates.
• One of the benefits of having a well-known and respected brand name is that firms can charge higher prices for the same products, leading to higher profit margins and hence to higher price-sales ratios and firm value. The larger the price premium that a firm can charge, the greater is the value of the brand name.

In general, the value of a brand name can be written as:

Value of brand name ={(V/S)b-(V/S)g }* Sales

(V/S)b = Value of Firm/Sales ratio of the firm with the benefit of the brand name

(V/S)g = Value of Firm/Sales ratio of the firm with the generic product

Illustration : Valuing a brand name: Kelloggs

The following is an analysis of brand name value at Kellogg Corporation. The estimates for Kellogg were obtained from 1994 financial statements. The after-tax operating margin for the generic substitute was obtained by looking at a private-brand cereal manufacturer. The expected growth is assumed to be

Expected growth in after-tax operating income = Retention Ratio * Return on Assets

The danger of double-counting the value of a brand name
The value of a brand name results in higher growth and higher value for the firm owning it. There are some analyses where the brand name value is double counted. To provide an illustration of how this could happen, assume that Coca Cola is valued using a discounted cashflow model and that the expected growth rate used in the valuation is 29.55%. This value already incorporates the value of the brand name through the use of the high growth rate. If an additional value is now assigned to the brand name, the brand name value is double counted.