A Blog by Jonathan Low


Oct 12, 2020

Why Covid Is Hastening the Shift To An Intangible Value Economy

The pandemic has accelerated the trend of value accruing to intellectual rather than physical capital through the safety, convenience and higher financial returns of remote connectivity. 

And this is expected to continue even after the healthcare crisis abates. JL

Greg Ip reports in the Wall Street Journal:

Value is increasingly derived from digital platforms, software and other intangible investments rather than physical assets and traditional relationships: taxi companies that don’t own taxis or employ drivers, hospitality companies that own no hotels, and media companies that reach their audience through the internet rather than broadcast licenses, theaters and cable. In the digital age, value accrues to ideas, R&D, brands, content, data and human capital— intangible assets—rather than industrial machinery, factories or other physical assets,”

If you had wanted to bet on a post-pandemic rebound in used-car sales this year, CarMax Inc. would have seemed the logical winner: It is the nation’s largest dealer with more than 200 stores, a big lending operation and a history of profit.

The stock market, however, has other ideas. Online retailer Carvana Co. sells less than half as many cars as CarMax, doesn’t use traditional stores and loses money. Yet its market value, slightly less than its rival’s at the end of 2019, is now more than double, at $37 billion.

Asset breakdown of S&P 500 companiesSource: Carlyle Group
.trillionTangible assetsIntangible assets1975'85'95'05'18051015$20

That divergent performance encapsulates a broader shift in the economy. Value is increasingly derived from digital platforms, software and other intangible investments rather than physical assets and traditional relationships.

That trend, long evident in the growth of big-tech platforms such as Google and Facebook Inc. and Amazon.com Inc., has intensified this year as the pandemic shifts interactions from in-person to virtual.

Technology has been facilitating the creation of new business models for decades, Jason Thomas, chief economist at private-equity manager Carlyle Group, writes in a new report, citing taxi companies that don’t own taxis or employ drivers, hospitality companies that own no hotels, and media companies that reach their audience through the internet rather than broadcast licenses, theaters and cable.

“The emergence and growth of ‘virtual’ businesses provided conspicuous evidence that, in the digital age, value accrues to ideas, R&D, brands, content, data and human capital—i.e. intangible assets—rather than industrial machinery, factories or other physical assets,” he writes.

In the industrial era, investors sought out companies trading for less than their book value—the assets on its balance sheet minus debt and other liabilities. Today, most value comes from intangible assets that typically don’t appear in book value: intellectual property such as patents and software, brands, and user networks. Between 1995 and 2018, intangible assets rose from 68% to 84% of the enterprise value (which includes equity and debt) of companies in Standard & Poor’s 500 stock index, Mr. Thomas estimates.

He calculates that in the last 10 years, the 10% of companies with the highest market-to-book ratios returned 18% a year on average, while the cheapest 10% returned less than 5%. Some of this reflects the performance of a handful of gigantic tech stocks, but this year high market-to-book-value companies have outperformed regardless of size.

The Value Isn't on the BooksYear-to-date return of stocks* divided intodeciles, from lowest to highest price-to-book-value ratioSource: Carlyle Group*Through Sept. 30; stocks in the Center for Researchin Security Prices database
Market value weightedEqual weightedLowestdecile9th8th7th6th5th4th3rd2ndHighest-40%-2002040

Recessions, Mr. Thomas writes, shock businesses into rethinking their business models. In 2008 the financial crisis froze the credit markets that finance companies’ property, inventory and payroll, spurring the popularity of “asset-light” business models such as ride-sharing. The pandemic has taught businesses to operate without offices and to engage customers virtually instead of in person, so they will likely further de-emphasize physical assets in favor of research, customer acquisition and data management, Mr. Thomas says.

Carvana is following in Amazon’s footsteps. Its website handles much of the trade-in and sales process. “Carvana probably has the premium platform today,” said Evercore ISI analyst Mike Montani. It added “transparency, convenience and an element of safety during the pandemic.” Customers can take delivery at home or pick up a car from a lot or from a vending machine—a glass storage tower.

The appeal of asset-light could also explain some of the extraordinary value assigned to Tesla Inc. Much of Tesla’s value is in its autonomous driving software, which costs a lot to develop but very little to install, thus yielding fat margins. In a May report, Morgan Stanley said Tesla’s full self-driving package (now an $8,000 option) could account for 6% of sales yet nearly 25% of gross profit by 2025.

Walt Disney Co. ’s dependence on assets such as resorts and cruise ships, not to mention theaters to show its movies, has left its revenue battered by the pandemic. But it now has an asset-light offset: a rapidly growing streaming business consisting of Disney Plus, Hulu and ESPN Plus with 100 million combined subscribers. Streaming lessens Disney’s dependence on theaters, broadcasting licenses and cable television to get its intellectual property in front of subscribers. It enabled Disney to offer its big-budget movie “Mulan” for downloading when many U.S. theaters were closed. In January, the market valued that streaming business at $108 billion, according to Barclays analysts, about half of the current market value of Netflix Inc., a pure streaming play.

The stock market may be right that asset-light businesses are the future, but that doesn’t mean it is right about who wins and what they are worth. Disney’s streaming businesses lose money, and Tesla, already valued at more than Toyota Motor Corp. and Volkswagen AG combined, faces intensifying competition for a still-tiny electric-vehicle market.

Carvana’s competition isn’t sitting still either. CarMax is building up its own online-sales operation to complement in-store sales, while startup Vroom Inc. is even less asset-intensive, relying largely on third-party reconditioning centers rather than its own. Mr. Montani said Carvana’s current valuation implies it will be the largest used-car dealer by 2030. But achieving that size, he said, will require more physical assets, including stores to cater to customers who still want to buy in person. Ultimately, the business models of Carvana and CarMax may converge, he said.


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