The Impact of Intangibles in M&A Transactions

When thinking about a company’s value, it is instinctive to think of its tangible assets. What are the main assets of an airline company? The answer may seem straightforward: “aircraft” one may say, complex machines sometimes worth over USD 200 million each. It may therefore come as a surprise to learn that, nowadays, the most valuable asset owned by major airlines consists of the data derived from loyalty programs created for frequent flyers.

Indeed, intangible assets can account for up to 90% of a company’s worth. This naturally raises the question: what are intangible assets, and how are they categorized?

Intangible assets are identifiable, non-physical assets that are controlled by the company and are capable of generating potential future economic benefits. The main categories include intellectual property (such as trademarks and patents), databases and customer relationships, licenses and concessions, and finally reputation and goodwill.

The Role of Intangibles in Extraordinary Transactions

In M&A transactions, intangible assets have a direct impact by significantly increasing the purchase price compared to what would be estimated if only tangible assets were considered. However, there are additional aspects regarding the role of intangibles in M&A transactions that are often overlooked:

• Purchase Price Allocation (PPA): accounting principles frequently require identifiable intangible assets to be separated from goodwill at the time of acquisition;

• Earn-out: in deals where the value of intangibles is uncertain, earn-out mechanisms are used, based on the future performance of the intangible assets;

• Goodwill: representing the excess paid over identifiable intangibles, which often consists of all intangible value that cannot be individually identified and therefore cannot be recorded. Goodwill may only be booked when acquired for consideration.

In the post-transaction phase, the impact of intangible assets lies in their integration into the newly formed entity and the ability to retain key employees who hold critical know-how.

Practical Experience

Lexsential Law Firm has handled several transactions where intangible assets proved crucial in enhancing the value of the new corporate entity. In 2015, the Firm advised on the sale of the surgical robotics division of an Italian client to a U.S.-based medical device company. The Firm was involved in renegotiating licensing agreements with the European Commission and in the valuation of filed patents.

In a 2022 deal, which involved the sale of 100% of the share capital of an Italian pharmaceutical company to a multinational, the Firm renegotiated licensing contracts to include clauses preventing termination in the event of a change of control.

Another notable example of the positive contribution of intangibles in M&A transactions is Luxottica’s acquisition of Oakley (2007) and its subsequent merger with Essilor (2017). In the first phase, Luxottica successfully integrated and leveraged internationally renowned brands, such as Oakley and Ray-Ban. In the second phase, following the merger with Essilor — which created EssilorLuxottica — the two entities combined Luxottica’s expertise in eyewear frames with Essilor’s expertise in lens quality.

Cases of Mismanagement

Of course, there are instances where inaccurate valuation, recognition, and/or protection of intangible assets during a transaction can lead to extremely negative consequences.

Although not a true M&A deal, the Italian case of Bio-On is highly relevant regarding the inaccurate valuation of intangibles. In 2019, U.S. investment fund Quintessential accused Bio-On S.p.A. — then listed and valued at EUR 1.3 billion — of entering into licensing agreements with related companies, often newly incorporated, and of manipulating financial statements by arbitrarily valuing licenses and patents. By the end of the case, in 2023, Bio-On was acquired for EUR 20 million by Gruppo MAIP S.r.l., which managed to preserve approximately 140 patents.

Another noteworthy case is Hewlett-Packard’s (HP) 2011 acquisition of Autonomy Corp. for USD 11.1 billion, which turned out to be a total failure. In 2012, HP had to write down the investment by USD 8.8 billion. HP accused Autonomy of inflating its intangibles by misclassifying low-margin hardware sales as high-margin software revenue. Additional factors included misinterpretations arising from the application of IFRS accounting standards in the UK (Autonomy’s home jurisdiction), rather than US GAAP, applicable in the U.S. where HP was based. HP had to write down goodwill by USD 5.7 billion and other intangible assets by USD 3.1 billion. Deloitte and KPMG, the consulting firms involved, were also criticized for failing to detect the anomalies.

Safeguarding Tools

What tools are available to professionals and companies to prevent disasters like those described above?

The first tool is due diligence. The general principle — that due diligence must be thorough yet effective in highlighting potential critical issues — applies equally to intangibles. While identifiable intangibles, such as trademarks, can be valued in a relatively simple manner (e.g., using income-based methods such as Discounted Cash Flow, or DCF, which is a valuation method that estimates the value of an investment based on expected future cash flows. Analysts use DCF to determine the value of an investment today, based on projections of how much money that investment will generate in the future), due diligence becomes far more complex when it comes to intangibles included in goodwill, such as know-how.

During the due diligence phase, contributions from additional professionals, such as brand experts, are crucial and it is equally important that all parties involved — external consultants as well as top executives — possess deep knowledge of the industry in which the post-deal entity will operate. Without such market knowledge, clients risk receiving a due diligence report that is formally flawless but practically incomprehensible to them.

Another key safeguard lies in contractual protection clauses, commonly known as reps and warranties, through which the buyer secures guarantees from the seller regarding the “health” of the company’s intangible assets.

Equally important are earn-out clauses, which adjust the purchase price after closing, based on the actual performance of the intangibles, whose value is often difficult to forecast precisely.

Periodic audits may also prove useful, enabling monitoring of the situation and the implementation of corrective measures in the exploitation of intangibles acquired through extraordinary transactions.

Looking Ahead

As it seems, globally there is still some reluctance by companies and their management relating to fully embracing the importance of the protection and the valorization of intangible assets, although in recent years there has been an increasing attention towards these matters.

The culture of intangible value is yet to take deep root also in Italy. Italian companies, however, are showing great adaptability. Once they understood the potential positive impact of intangibles on corporate value, they began to implement relevant strategies. A key example is Luxottica (now EssilorLuxottica), which in 20 years climbed the global ranks mainly thanks to the quality of its products (protected by IP rights) and the reputation of its brands (such as Ray-Ban).

Nonetheless, as it often happens, Italian companies are not at the forefront of these developments. Major innovations in the valuation and management of intangible assets usually arise abroad and are later imported into Italy. Going forward, the Italian legal professional will also serve as a “bridge,” importing knowledge gained from foreign doctrine and case law, as well as from cross-border deals, for the benefit of Italian companies.

A cura di

Avv. Stefano Candela
Dott. Dimitri Cuzzocrea

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