F. Peter Boer

Valuation of Technology Using “Real Options”

OVERVIEW: Cash flow models for valuing technology are increasingly out of touch with market-place valuations. While investor psychology and perceptions about the future may drive the marketplace, the theory of real options can go a long way toward closing the valuation gap. More importantly, it is a quantitative method, and is responsive to changing sets of assumptions. This article focuses on the importance of separating unique and market risk in applying options theory to R&D projects, since the former impacts value negatively while the latter enhances value. It also illustrates how the hidden options in a new venture can contribute enormously to value, especially in fast-growing industries and in markets exhibiting high volatility.

TRAPS, PITFALLS AND SNARES IN THE VALUATION OF TECHNOLOGY

Unlike ordinary physical and financial assets, innovative technology is disturbingly intangible, often financially invisible, very risky, and dependent on linkages to other assets for realizing its value. OVERVIEW: In a world where financial wizards are seeking to maximize value for shareholders through corporate restructuring, mergers, acquisitions, and spin-offs, there is no escaping the question of how one values technology. The consequences of mis-valuing it, however, can be unfortunate. This article introduces the prevailing free cash flow method for valuation and the significant pitfalls that can occur in misuse of hurdle rates or miscalculating horizon value. It is equally important to recognize that much of the value of RD examples range from Genentech to Netscape. Investment decisions make the need for valuation of technology inescapable. And financial analysis may be too important to leave to the financial analysts. Valuing Assets There is a well-established textbook method for valuing assets, based on discounting future free cash flow from an investment at the rate that can be earned by alternative investments of comparable risk (4, pp. 11-52). Readers unfamiliar with the method would be advised to consult a finance text. I do not quarrel with this approach, and shall summarize it below as a starting point for subsequent discussion. Briefly, free cash flow is the sum of net income, and, if applicable, depreciation, less net capital investments required to sustain the asset. The discount rate is often also referred to as the cost of money (C). Two terms are often used in association with this form of analysis: net present value (NPV) and internal rate of return (IRR). NPV is calculated by discounting the cash flow of each successive year (n) by the cost of money, at a rate (1/C)n. Case A in Table 1 calculates the NPV of a

Risk-adjusted Valuation of R&D Projects

1000 investment with cash flows of

Financial management of R&D 2002

300/yr for five years, assuming a discount rate of 12%. …

One Point of View: Globalization of Technology—What It Means for American Industry

OVERVIEW: The decision-free approach to the valuation of R&D projects is mathematically identical to a probability-adjusted sequence of real options, when systematic (or market) risk is set to zero. Besides adding confidence to the calculation, this observation allows a clean separation of the value contribution of the option to abandon contained in a stage gate approach plus the additional value gained from market risk (as measured by volatility). One consequence is to enable the risk-adjusted valuation of R&D projects on a compact and familiar set of variables: net present value, initial investment, and the estimated cost, duration and probability of success for each R&D stage. An estimate of the value of the project at the completion of each successive R&D stage is also a useful output of the method.

Molecular Orbital Theory for Large Molecules. Approximation of the SCF LCAO Hamiltonian Matrix1

OVERVIEW: Financial thinking about R&D has evolved well beyond basic discounted cashflow models. Better tools have been developed to value intellectual capital, including the quantitative assessment of the value added by R&D. The dissection of the elements of risk and the application of real options theory are new features of the R&D landscape. Financing vehicles have also changed with an enormous surge of venture capital and private equity funds. The analysts toolbox has been enhanced by electronic spreadsheets, on-line databases, Monte Carlo software, the Internet, and the ubiquitous personal computer.

Structural studies of pentacoordinate silicon. IV. m-Nitrophenyl(2,2',2''-nitrilotriethoxy)silane

A major change is taking place in the function of the modern RD clearly, a careful look at the technology side of the acquisition is an essential part of the due diligence process. The R&D organization is increasingly being respected for its role in this activity. Of course, some acquisitions represent acquisitions of technology rather than market positions. This is often referred to as reverse technology transfer, or licensing-in. At W. R. Grace, for example, we have created a specialized group in our Japan Research Center whose prime mission is to identify technologies and markets emerging in Japan that are worth licensing-in, and to create the initial contacts by which that process will occur. So far, this activity has been quite successful for us. We would note here that there is a major difference between having a technology office in Japan to do licensing-in activities--that is, to have a seasoned executive with some financial and legal assistance search out acquisition opportunities--and having a research laboratory itself do it. We are now investing in people who are state-of-the-art specialists in their field in Japan and who work with their counterparts in other Japanese companies, to validate these technologies, to work in joint ventures, and to help effect the proper transfer of that technology into Grace. We believe this approach has been very successful. MANAGING TECHNOLOGY PORTFOLIOS When one adds all this up, we are saying that the R&D organization is increasingly being charged with the job of managing and restructuring the corporations technology portfolio, and its success would have to be measured in terms of what it has brought to that portfolio. …