Twitter IPO: Why a good trade be a bad investment (or vice versa)?

In my last post, I valued Twitter at about $10 billion. I made a ton of assumptions to get to that value and I argued that changing those assumptions could give you a different value. In the last few days, I am sure that you have seen many stories about Twitter’s post-IPO worth, with numbers as high as $25 billion being offered as estimates. In fact, the gambling markets have already opened on the offering price and the players in that market seem to be siding with the higher numbers. As an investor on the side lines, I don't blame you if are probably completely confused about these competing and divergent numbers but there is a way in which you can start making sense of the process.

To set the table, I am going to go back to a theme that I have harped on before in my posts and that you are probably tired of hearing. When talking about investing, we often talk about “value” and “price” as if they are interchangeable, but they are not. In fact, in my post two weeks on Twitter, prior to its financial filings, I tried to price the company (as opposed to valuing it) and came up with a wide range of numbers, depending on my scaling metric (users, revenues etc.). That confusion between value and price lies at the heart of why it is impossible to have a conversation of how much a stock is worth, when the parties to the conversation come from different camps. So, to decipher the difference, I decided to go back to basics and tried to lay out the differences between the pricing game and the valuing game, as I see them.

The Pricing Game versus The Value Game

	The Pricing Game	The Value Game
Underlying philosophy	The price is the only real number that you can act on. No one knows what the value of an asset is and estimating it is of little use.	Every asset has a fair or true value. You can estimate that value, albeit with error, and price has to converge on value (eventually).
To play the game	You try to guess which direction the price will move in the next period(s) and trade ahead of the movement. To win the game, you have to be right more often than wrong about direction and to exit before the winds shift.	You try to estimate the value of an asset, and if it is under(over) value, you buy (sell) the asset. To win the game, you have to be right about value (for the most part) and the market price has to move to that value
Key drivers	Price is determined by demand & supply, which in turn are affected by mood and momentum.	Value is determined by cash flows, growth and risk.
Information effect	Incremental information (news, stories, rumors) that shifts the mood will move the price, even if it has no real consequences for long term value.	Only information that alter cash flows, growth and risk in a material way can affect value.
Tools of the game	1.     Technical indicators 2.     Price charts 3.     Multiples & Comparables 4.     Investor psychology	1.     Ratio analysis  2.     DCF valuation 3.     Excess Return models
Time horizon	Can be very short term (minutes) to mildly short term (weeks, months).	Long term
Key skill	Be able to gauge market mood/momentum shifts earlier than the rest of the market.	Be able to “value” assets, given uncertainty.
Key personality traits	1.     Market amnesia 2.     Quick acting 3.     Gambling instincts	1.     Faith in “value” 2.     Patience 3.     Immunity from peer pressure
Biggest Danger(s)	Momentum shifts can occur quickly, wiping out months of profits in a few hours.	The price may not converge on value, even if your value is “right”.
Added bonus	Capacity to move prices (with lots of money and lots of followers).	Can provide the catalyst that can move price to value.
Most Delusional Player	A trader who thinks he is trading based on value.	A value investor who thinks he can reason with markets.

If you play the pricing game, you are a trader, and if you play the value game, you are an investor. I am not passing judgment, when I make this statement, because unlike some value investors, I don’t view traders as shallow or somehow less critical to the functioning of markets than investors. After all, a trader who makes a million dollar profit can buy just as much with that money as an investor who makes the same profit.  Ultimately, which avatar (price or value) best fits you will depend not only on your level of comfort with the tools (Are you better at reading charts or valuing companies?) but also on your personal traits. In my experience, naturally impatient people who are easily swayed by peer pressure almost never succeed as value players and excessively cerebral folks who have to weigh everything in the balance, before they make decisions, are incapable of being traders. 

This black and white view of the world may strike as some of you as extreme. After all, why not allow for shades of grey, traders who are interested in value and investors who think about the pricing process? While I will dive into this netherworld in future posts, I will not in this one, for two reasons. The first is that many of self-proclaimed hybrid investors are nothing of that sort. There are traders who pay just lip service to value, while using it back their momentum plays and investors who claim to respect markets but only until they start moving in the wrong direction. The second is that there is a danger in playing on unfamiliar turf: traders who delude themselves into believing that they understand value can undercut their own effectiveness just as much as investors who think that they can get in and  out of markets, when it suits them. A healthy market needs both traders and investors, in the right balance. A market that has no traders and all investors will have no liquidity and one that has all traders and no investors will have no center of gravity. Ironically, each group needs the other for sustenance. Trading and momentum cause prices to move away from value, creating the bargains that investors try to exploit, and in the process of exploiting them, they create the corrections and momentum shifts that other traders exploit. 

This, of course, brings me back full circle back to Twitter. If you are a trader, ignore almost everything that I said in my valuation post but do pay some attention to my pricing post. Even if you believe that my valuation assessment of $10 billion is a reasonable one, that should not stop you from buying the stock, even if it is priced at $20 billion, if you think that the market mood will take it higher. If you are an investor on the other hand, considering adding Twitter to your investment, it matters little how much hype or momentum underlies the stock. If your assessment of value is close to mine, it is not a good investment for you at a price higher than that value. As you listen to the debates about Twitter's worth in the next few weeks, recognize that if the argument is between an investor and a trader, they are talking past each other. Stealing from the title of the bestseller from a few years ago, if traders are from Venus, investors are from Mars, and if one is talking about price and the other about value, they may both be right, even with vastly different numbers. Twitter can be a good trade and a bad investment at exactly the same time!

Twitter announces IPO: The Valuation

A little more than a week ago, I posted my first take on Twitter and argued that even in the absence of financial information from the company (since the prospectus had not been filed yet), you could price the company. Based on prior transactions in the company (VC infusions and acquisitions) and the multiples of revenues/users for other companies in the space (the social media medley, as I called it), I argued that Twitter would be priced at about $12 billion by the bankers. 

I also argued that as a long term  investor, focused on value, you could not buy the stock, at any price, unless you gauged its value first, and promised to return to the company and value it, once the filings were made. Twitter did file its S-1 (the pre offering filing) late in the day on October 3 and I am going to give it my best shot. Since I will reference this filing through my valuation, you should download the filing and use it to not only follow my estimates but to change those that you don't agree with. As with all of my valuations, I would hasten to add that this is my valuation and while it informs my decision on whether to buy or sell the stock, you should make your own best judgments about the company. (I know that this resembles the boilerplate disclosure that you see in every email that you get from your broker but I really mean this and I am not saying it to avoid getting sued.)

The state of the company

Before I embark on the ambitious task of forecasting the future, I will begin by looking at the company as it stands now. The financial filings paint the picture of a young company with little in terms of conventional earnings or cash flows to back it up, but plenty of promise (a dangerous word). Let’s start with the income statement. In the table below, I list the company’s key income statement numbers from 2010 to 2012, with the 2013 data in the last three columns.

The numbers paint a picture that should not be surprising. The company’s revenues have grown rapidly, with the revenues in the first 6 months of 2013 jumping more than 100% from the revenues in the first 6 months of 2012. Notwithstanding the jump, though, the revenues over the twelve months ending June 30, 2013, were only $448 million (which is well below the rumored $583 million that I used in my pricing post). The company has reported operating losses through its entire life, though to be fair, R&D expenses account for a chunk of the operating expenses. The company does report an adjusted EBITDA, and while the trend is positive, I cannot read much significance into a number that is based on the fiction that employee expenses can be added back because they are non-cash. Allowing for the fact that R&D is really misclassified capital expenditures (by accountants) and assuming a 3-year amortizable life for R&D does improve the operating income somewhat, as does the capitalization of operating lease expenses (moved to debt). Even with this improved operating income, Twitter’s pre-tax operating margin is barely positive (0.96%). 

Looking at the balance sheet just adds to the narrative of Twitter as a young, early-in-the-lifecycle company, as can be seen in the following table:

These numbers illustrate how completely useless accounting balance sheets  are at young firms, especially in technology. In fact, the only number in this balance sheet that has any relevance is the cash balance, with the intangible asset item measuring none of the true intangibles and goodwill playing its usual (and useless) role as plug variable. I capitalized their past R&D expenses and am showing it as an asset. The book value of equity is negative but as an investor, that tells me nothing, and the shift to a positive book value of equity in the pro forma statement matters even less. The company has little debt (a capital lease) and a series of convertible, preferred share offerings, reflecting its multiple VC capital infusions, which will get converted to equity on the public offering (removing a major headache in the valuation). Comparing Twitter’s financials to Facebook’s at the time of its public offering (see my valuation of Facebook on the day before its offering) should make it clear that Twitter is much earlier in its growth path than Facebook. 

The IPO set up

Valuing a company, just ahead of a public offering, is tricky for multiple reasons. The first is that there is a feedback effect from the offering itself, since the cash retained from the offering augments the value from the firm (if the founders don’t cash out). The second is that the share count is a key and shifting number, with conversions of other types of securities (preferred in this case) and shares used in employee compensation (restricted stock units (RSUs) and options) overhanging per share values.

1. Magnitude of the initial offering: While this may be putting the cart before the horse, the first number that you need to estimate is the dollar value that the company hopes to raise in the initial offerings. In most IPOs, only a small fraction of the company is offered and Twitter seems to be no exception. This news story suggests (and I tend to believe it) that Twitter plans to raise about $ 1 billion in the offering, at a stock price of roughly $20/share. Note that I am not suggesting that this is the right value for the share and it will really not affect my valuation.
2. Use of the offering: On page 16 of the S-1, Twitter specifies that it plans to retain the proceeds from the offering in the company and use it to cover investment needs (acquisitions, capital expenditures and working capital). That effectively means that the day of the offering Twitter’s cash balance will increase by roughly $1 billion, if that is the offering amount. (In some IPOs, the founders of the company cash out a portion of their ownership and take the offering cash out of the company. In that case, it would not augment the cash balance). 
3. Post-offering shares outstanding: As I noted in the last section, Twitter has a whole series of convertible preferred offerings. On page 17, the company notes that all of the convertible preferred shares will be converted into common shares, removing one potential entanglement. On the same page, the company specifies that it expects to have 472.613 million shares outstanding after the offering, but then proceeds to say that this number excludes 44.157 million employee options (potentially convertible to shares), 86.915 million shares of restricted stock units (also granted to employees), 0.117 million shares issuable on a warrant and 14.791 million shares to be issued to MoPub stockholders as payment for the acquisition. There is absolutely no valuation basis for excluding these shares and the total number of shares that I will use in my per share value is 574.44 million (472.613+86.915+0.117+14.791). The options also represent a claim on equity value, but I will deal with them separately. 

Valuing Twitter
The value of Twitter lies in what it can do with its 215 million users (the estimate in the S-1) rather than what it has done in the past. This is the section where I am sure that we will have to agree to disagree but the following sections summarize my assumptions.

A. Cash Flows/Earnings
1. Revenue Growth: The first leg of value creation for Twitter is for it to be able to grow its revenues out, from the $448 million in the most recent twelve months. To get some perspective on what the potential for revenue growth is in this sector, I started by looking at the latest assessments of the size of the online advertising market. While the estimates vary across sources, this one (from eMarketer.com) looks like it is close to reality (with the percent market shares and dollar revenues in billions):

There are two factors to keep in mind. The first is that the online portion of the advertising market is continuing to capture a larger share of overall advertising revenues (as attested to by the woes of print and traditional media companies); applying a 5% growth rate to 2013 online ad revenues yields a value of $190 billion for the overall market in 2023. The second is that there is a large segment of the market currently that is splintered among thousands of other companies, some conventional press media and many very small. Thus, the good news for Twitter is that there is a large potential market, but the bad news is that there will be plenty of competition from both the existing players and new entrants. In fact, one interesting and disquieting aspect of the inflation of market values of many of the companies on this list is that the market does not seem to be factoring in the finite size of the overall market. Thus, Google's current market cap implies that market expects its revenues will increase to $75 billion by 2023 and Facebook's market cap implies a revenue of $60 billion for that company; if the market is right, those two companies alone would account for 60-70% of the overall market in 2023.  I do think that Twitter starts with some advantages. While it does not have Facebook's user base (or expansive interface) and Google's easy reach, it does have a much-used and unique platform and an active user base. I will assume that Twitter's revenues will reach $11.5 billion in 2023. That will be more than a twenty fold increase in revenues and translate into a revenue growth rate of 55% for the next 5 years, scaling down to stable growth (of 2.7%) in year 11.

2. Target Operating Margin: Twitter's losses may be getting smaller and capitalizing R&D and lease expenses does make their operating margin for the last twelve months slightly positive (0.96%), but it is clear that Twitter's value as a company will eventually be determined by how much profits they can generate in the future. To make an estimate of the pre-tax operating margin that Twitter will be able to generate, once it gets through its growth pains, I took a look at a mix of firms that I would classify as the  social media medley:

It is difficult to compare margins across these companies, since some (like Netflix) derive all their revenues from subscription revenues, some (like Pandora) have a mix of advertising and subscription revenues and some (like Google & Yahoo) are search engines. The company that is closest to Twitter in its advertising revenue model is Facebook and the company delivers an impressive 30% pre-tax operating margin, but Facebook's margin has shrunk as its revenues have grown. Will Twitter be as profitable as Facebook? There are news stories that suggest that Twitter gets less revenues from advertising per user than Facebook, but those may be reflective of where Twitter is in its growth phase. Twitter, with its 140 character limit, has a more constrained format for ad delivery but may work better in mobile advertising (which is the cutting edge of online advertising) than Facebook. Overall, though, I would anticipate Twitter to have a slightly lower operating margin (25%) than Facebook does now (30%), especially since Facebook's margins will also compress over time.

3. Reinvestment to deliver growth: Growth is never easy, nor is it ever free. With high growth companies, the tool I use to estimate reinvestment is the ratio of sales to invested capital (with higher numbers translating to more productive growth). To get a sense of what this number will look like for Twitter in the future, I took a look at Twitter's limited past and at Facebook's numbers:

Note that for Twitter, I have computed the ratio of incremental sales to reinvestment each year from 2010 to 2012, and that my reinvestment number includes acquisitions, change in working capital capitalized R&D and is net of depreciation.  I have also computed the total sales to invested capital  for Twitter, Facebook and the sector in 2013. While Twitter's incremental sales to reinvested capital ratio has risen over time, it is still below the industry average. Put in intuitive terms, Twitter is spending large amounts (on R&D and acquisitions) to deliver its revenue growth and you have to hope for improvement as the company gets larger; Twitter specifically forecasts about $225-275 million in acquisitions for 2013 (S-1, Page 51). Based on these data, I assume that for every $1.50 increment in future revenues, Twitter will have to invest a dollar in capital; this allows me to estimate the reinvestment (including net cap ex, change in working capital, R&D and acquisitions) each year.

B. Risk/Cost of capital
 Is Twitter a risky company? Of course, but to estimate the rate of return that I would demand to cover its risk, I looked at three components:

1. Business mix: While the bulk of Twitter's revenues come from and will continue to come from advertising, Twitter does have a data trove of past tweets that may be mined for commercial or research reasons. In the first six months of 2013, Twitter generated 12.6% of its revenues from its data services and this proportion will probably decline in the future. Using a business mix of 90% advertising and 10% from data services yields a beta of 1.40 for the company. (Beta for Twitter = (0.90) (Beta for advertising) + 0.10 (Beta for data services) = 0.9(1.44)+0.1(1.05) = 1.40)
2. Geographic mix: While Twitter generated very little of its revenues from outside the US in 2011 and 2012, about 25% of its revenues came from the the rest of the world in 2013. Using an equity risk premium for the US of 5.75% and a GDP-weighted average equity risk premium of 7.23% for the rest of the world, with the current weights of 75% and 25% for each, yields a value of 6.15% for Twitter. Given that Twitter now has far more followers outside the US than in the US (S-1, Page 67), the proportions and equity risk premium may shift in the future. 
3. Financing mix: Twitter has capital leases of $71 million and the capitalized value of operating leases is $127 million. Collectively, debt accounts for 1.69% of capital and Twitter's cost of capital, given these assumptions, is 11.22%.

C. Loose Ends
Getting from the value of the operating assets to the value of equity per share in Twitter requires us to get over a series of speed bumps:

1. NOL & Taxes: The company's operating losses have resulted in a net operating loss of $468 million (S-1, page 217) which I use to shelter the company's income, when it does start making money, from taxes. As a result, I do not expect the company to pay taxes until year 5. Once it starts paying taxes, I assume that it will face an effective tax rate of 30%, which over time will move to the marginal tax rate of 35.50% (S-1, page 211) after year 10.
2. Cash & IPO Proceeds: I add up the cash and short term investments of the company (see page 173) to arrive at a cash balance, which is added to the value of the operating assets. Since I have assumed that the IPO proceeds will be $1 billion and that they will be retained by the firm, I add that value to the cash.
3. Capital & Operating leases: As mentioned in the risk section, I did convert the operating lease commitments of the company (page 214) to debt and added it to the capital leases to arrive at a total value of debt of $299 million.
4. Survival Risk: While young companies with operating losses are susceptible to failure, I will assume that Twitter's deep pocketed equity investors will bring in capital, if the company gets into trouble, rather than leave value on the table. I have assumed that there is a 100% chance of the company surviving.
5. Option overhang: The company has 44.16 million options outstanding, with a strike price of $1.82 (S1- page 207). Halving the remaining life on these options, to reflect the empirical reality that employee options get exercised about halfway through their lives, gives me a life of 3.47 years and in conjunction with an estimated standard deviation from the company of 53.6% (see page 207) yields a value of $805 million for these options (net of tax benefits in the future).
6. Classes of shares: The best news I see in this filing is that there is no mention of two classes of shares (with different voting rights) or special corporate status (which I did see in the Facebook filing). While that may change in future revisions, that does make my job easier in terms of estimating value of equity per share.

The net effect of these adjustments is to get a value of equity of $9.97 billion for the equity in common stock and a value per share of $17.36. The picture below captures the various assumptions in the valuation and you can download the spreadsheet with the valuation.

If you do not like my assumptions, please change them and come up with your own estimate of value. If you are so inclined, please do enter your numbers in the Google shared spreadsheet that I have created.

Decision Time

Having learned from the Facebook fiasco, I  expect the bankers and the company to make the Twitter IPO a smoother offering. That process will of course start with the road show, where they will package the company like a shiny new present, and unwrap their “offering” price. I am sure that Goldman’s bankers, working on this deal, are a capable lot and will price the stock well, with just enough bounce to make those who receive a share of the initial offering feel special.  As I watch the frenzy, I have to remind myself of two realities. The first is that there will be lots of distractions (like this one) during the IPO, most designed to take my eye of the ball. The second is that the bankers have their own agenda, and I cannot make the mistake of assuming that it matches mine. Watching out for my interests, here is how I see Twitter: at a $6 billion market cap ($10/share), I think it is a very good deal, at $10 billion ($17.5/share), I am indifferent to it, and at $20 billion ($35/share), it is a moon shot. Could I be wrong? Of course, but I would rather be transparently wrong (hence the long blog post detailing every assumption that I made) than opaquely right. I welcome disagreement (though I would much appreciate your phrasing it agreeably).

1. Twitter S-1 filing
2. Twitter valuation (mine)
3. Google shared spreadsheet for Twitter valuations

The Brand Name Advantage: Valuable, Sustainable and Elusive

The Interbrand rankings of the top brand names in the world are out. As always, they have created buzz in the financial press, with the big news story being the displacement of Coca Cola from its perennial number one spot and the rise of technology companies (Apple and Google have the first two spots and there are four other tech companies in the top ten) in the rankings. Here is the listing of the top ten brand names from 2012 and 2013: 

Interbrand, in addition to ranking the brands, also provides estimates of value with Apple’s brand name value estimated at $98.3 billion and Coca Cola’s at $79.2 billion.

Why brand name valuation matters

If you are an investor or even a corporate manager, you may believe that these brand name rankings matter little, since all they do is parse the value of a company into its component parts. These rankings do, however, raise interesting questions about the power of a brand name and how it manifests itself in earnings power and in value. In fact, there are good reasons why you may want to value brand name independently. From a valuation perspective, separating how much of the value of a company can be attributed to its brand name is important in a variety of contexts: 

1. Sale of a brand name: If a company is considering selling its brand name alone, while holding on to its physical assets, you have to be able to value the brand name separately from the rest of the business. 
2. Legal disputes over brand names: Brand names become the subject of legal disputes, with each party claiming the lion’s share of value. Without knowing how to value the brand name and the drivers of that value, you cannot apportion the value to the disputing parties. 
3. Accounting “fair value”: The shift in accounting towards fair value from original book value has opened the door to accountants also trying to estimate the value of intangibles such as brand names, trademarks and customer lists. While I don’t think this is a good idea and have said so in other forums, it is clearly the trend in international accounting. 

From a marketing perspective, where brand name has historically occupied a much more central position, you need to understand what goes into a brand name and how to value it in the following circumstances: 

1. Advertising spending and evaluation: If one of the key roles of advertising is building up brand name, understanding how much brand name is worth is key to both how much you spend on advertising and how you spend it. It is also a critical component in assessing the effectiveness of advertising in delivering a higher brand name value. 
2. Pricing and product decisions:The products that you offer and how you price them will depend can be affected by and can have an effect on your brand name value. Thus, if you are an elite brand name apparel company, you may choose not to introduce a lower priced product out of fear that it will hurt your brand name and thus your value.

The power of a brand name 

While there are some who bunch together all of the competitive advantages possessed by a company into the “brand name” category, I think we are better served isolating brand name from other competitive advantages. Consequently, I have a narrow definition of the power of a brand name, which I am sure that some of you will take issue with. 

Brand name power: The power to charge a higher price than your competitors for an identical or almost identical product or service.

To provide an illustration of pure brand name power, I took a stroll through my local pharmacy and found these two bottles in the painkiller aisle: 

The generic aspirin was priced at $2.25 and the Bayer version was priced at $6.00. Aspirin, of course, has been off patent for decades and the ingredients in Bayer Aspirin and its generic counterpart are identical. Clearly, though, there are customers who are willing to pay a premium for the Bayer Aspirin, notwithstanding that reality. In fact, you can find multiple examples of this generic/brand name price disparity through grocery stores and pharmacies. 

So, what explains the pricing power of a brand name? It would be far too easy to get on a soap box about consumer irrationality, but I would not dare to do so, because I am sure that we have all been guilty of this irrationality, if not with Aspirin, with other products. Brand name power is a testimonial to how our choices as consumers are driven not just by product characteristics and prices, but also by an array of behavioral factors. It is no wonder then that the secrets to creating a valuable brand name are shrouded in mystery. If it were just spending advertising dollars, the big ad spenders should dominate this list of top brand names but there are many who don’t show up. Conversely, there are companies that seem to come out of nowhere and become valuable brands in short periods: Snapple in the early 1990s, Lululemon and Under Armor in the last few years. Brand name value is as much a function of luck and serendipity as it is a function of planning and design.

The value of a brand name

If you accept my definition of brand name power, the process of valuing it then becomes simple, at least in the abstract. It would require you to answer the following question: If you are a brand name company and you lose your “brand name” overnight (consumers develop selective amnesia), what would happen to the value of the company? 

That question is easier posed than answered because facile comparisons don’t quite capture the effect. Thus, comparing the market capitalization of Coca Cola to the market capitalization of a generic brand name company will tell you little about brand name value. While the comparison of pricing multiples (PE, PBV or EV/Sales) between brand name companies and their generic counterparts are more useful, there are still too many unknowns to control for. As I see it, the only way to value brand name is to use an intrinsic valuation model, identify the drivers of value and then look at how brand name and generic companies differ on those drivers, with consequences for value. 

Rather than talk in abstractions, let’s pick a company: Coca Cola. Though it may have dropped out of the top spot on Interbrand’s list this year, it remains an iconic brand name, recognized in almost every corner of the world. To value the brand name of the company, I have to first identify differences on key valuation metrics between Coca Cola and a generic counterpart. In this case, I was able to find a generic manufacturer of beverages, Cott Inc., a Canada-based company that produces beverages that can be branded by grocery stores as their own. To illustrate the enormous advantages that Coca Cola’s brand name endows it with, I compared the two companies in the table below: 

	Coca Cola	Cott	Measures
After-tax operating margin	17.07%	4.08%	Pricing power
Sales/ Invested Capital	0.97	1.89	Revenue productivity
Return on capital	16.54%	7.73%	Investment success
Cost of capital	7.31%	8.51%	Cost of funding
Excess return	9.23%	-0.78%	Value added

Note that Coca Cola’s after-tax operating margin of 17.07% is almost 3.5 times higher than Cott’s after-tax operating margin of 4.08%; the return on capital for Coca Cola is 16.54%, 9.23% higher than its cost of capital of 7.31%, whereas Cott’s return on capital of 7.73% lags its cost of capital of 8.51% by 0.78%. 

So, how do we devise a pathway from these numbers to a value for Coca Cola’s brand name? This is after all not meant to be a comparison of Coca Cola with Cott, two companies of vastly different scale. Here are a couple of options: 

Option 1 (Coke's margin = Cott's margin): Assume that Coca Cola loses its brand name overnight and that it’s operating margin converges on Cott’s operating margin of 4.08%. That drop in margin has ripple effects, lowering the return on capital and growth rates. Holding revenues and the cost of capital fixed, that translates into a value for Coca Cola’s brand name of $149.5 billion. 

Option 2 (Coke's ROIC = Cott's ROIC): One reason that option 1 may over estimate the value of the brand name is because Cott is more efficient in generating revenues per dollar of capital invested ($1.89 per dollar of invested capital) whereas Coca Cola generates only $0.97 per dollar of invested capital. Giving Coca Cola both the margin (4.08%) and the sales to invested capital ratio (1.89) that Cott has effectively gives it Cott's ROIC (7.73%) and this reduces the value of the brand name to $120 billion. 

Extending this approach to other brand name companies, you may face one potential hurdle: finding a generic competitor. Even in the case of Coca Cola, you may take issue with the use of Cott Inc. since it margins may not be reflective of the margins of a generic company. One solution is to look at the distribution of key metrics (ROIC, operating margin, sales to capital ratio) across the sector. For instance, looking at the distribution of return on invested capital across global beverage companies: 

Note that the distribution is split, with lots of companies at either end of the distribution: high ROIC and low ROIC. You can then use the median ROIC (or some lower percentile if you prefer) of the sample of 11.07%  as your generic ROIC and use it in your valuation). There are other choices that you can make: that all of the excess returns are due to brand name, that Coca Cola earns the same excess returns as Cott etc. The value for the brand name ranges from $90 billion to $150 billion, depending on your choices and you can see them all in this spreadsheet.

Note that this approach works well for Coca Cola, since there is little else other than brand name that separates one sugared, colored beverage from another. It is much more difficult to do this analysis for Apple, where you can argue that pricing differences are only partially driven by brand name and can also be explained by differences in operating systems, features and quality. Thus, while we can estimate the portion of Apple’s value that can be attributed to all of these competitive advantages collectively, parsing it among the advantages can be in the eyes of the beholder. 

Implications

1. Brand name is one of the most sustainable competitive advantages in business: There are very few competitive advantages that have survived as long as brand name. A technological edge can be lost and economies of scale can be matched but brand names often endure the slings and arrows of competitive fortune. 
2. Brand name is not the only competitive advantage: Not all valuable companies have a valuable brand name (Eg. Walmart, Exxon Mobil) but they have other competitive advantages; Walmart’s edge comes from unmatched economies of scales and supply chain management whereas Exxon’s come from its reserves). Even some of the companies on the Interbrand list have questionable brand name values. As I see it (and I am biased), Microsoft’s competitive advantage has not been its brand name. With both Windows and Office, the company has used a mix of overwhelming force (packing the products with features that most of us never use) and a networking effect (where not using them makes you the odd person out) to win. 
3. Misidentifying your competitive advantage can be dangerous: You may feel that the parsing of competitive advantages that I am doing is pointless, since they all lead to excess returns, but I do think that it matters. If you do not know what your true competitive advantage is, it will not only be difficult to nurture it but you may put it at risk with your actions. Thus, while brand name value is a sustainable advantage, its benefits can still be lost by careless, deluded or distracted managers. A classic example is Coca Cola’s ill-fated attempt in 1986 to introduce New Coke, in a misguided belief that it was taste that mattered, when in fact it had little to do with Coca Cola’s success. 
4. Investor alert: If you are an investor in a company whose primary competitive advantage is brand name, the primary risk you face to your wealth is not that the company’s growth will lag (though that is always a concern) but that its pricing power will dissipate. In pragmatic terms, investors in brand name companies should track operating margins at these companies, staying alert to slippage.

Brand name spreadsheet: Generic spreadsheet for valuing brand name

My paper on valuing brand name and other intangible assets