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What you should know about appraisal values in a changing world economy 06/10/2004. Source: Bank Of America Business Capital. Robert Maroney 
 Accurate appraisals are the very foundation of asset-based loans. Companies count on them to ensure that their borrowing power is maximized while lenders rely on them to support the value of the credit they are extending, according to Robert Maroney of Bank of America Business Capital.
But since asset values and the forces that affect them fluctuate, approaches to
valuation and asset disposition also must evolve to meet them. Over the past several
years, driven by the economy and increased globalization, the appraisal industry
has undergone numerous changes. 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 as they’ve
had a substantial influence on 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.
The 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 consequence, the sell-through approach has dramatically
changed the way inventory is ultimately valued.
Used Equipment Market Faces Challenges
With the sizeable migration of manufacturing facilities to less expensive foreign
locations, a higher percentage of used manufacturing equipment is being marketed
outside of the U.S. In the U.S., buyers for late-model equipment still can be
found but, depending on the industry, typically only foreign buyers are interested
in older equipment.
One industry that’s been 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 the cost of shipping makes
it difficult 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.
Due to its vast population and cheap labor, China also has been a major force
in the overseas movement. It drove the price of steel through the roof by buying
scrap metal in any shape and form from all over the world, melting it, reusing
it and ultimately selling many of the finished goods back to the U.S. China’s
legal and financial systems also have evolved and the country has been successful
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 issues such as 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 who are most familiar with supply and demand issues in those countries.
The growth of the international equipment market 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. So, while worldwide competition
for goods doesn’t help U.S. producers, it does create a place to sell
equipment.
The 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, the Internet connects sellers
of equipment 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 Web-cast auctions have narrowed the gap between the auction value
and the orderly liquidation value. Most major liquidation companies send regular
emails identifying equipment for sale, and announcing public auctions. This
additional exposure to the marketplace almost certainly has increased recoveries
for used equipment sales. On the inventory side, 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, over
the past few years 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 begin including 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. Trade names already being licensed,
and generating existing royalty streams, can be valued with a high degree of
accuracy. 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 a brand name, can have a significant impact
on recoveries in the event of liquidation. Although intangible valuations need
to be reviewed carefully when being considered as collateral support, in some
cases, 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. It’s also highly specialized. 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.
The 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 these changes are factored into the
process of determining its ultimate value.
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