Knowledge Leaders Don’t Need Your Bank Loans, Thank You Very Much by Jennifer Thomson, Gavekal Capital Blog

When we read this Bloomberg article about concerns regarding the ECB’s announcement of an expansion in its Targeted Longer-Term Refinancing Operations (TLTROs)– and the assumption that European banks will simply use them to “paper over the cracks in the finance industry’s balance sheets without funneling extra money into the real economy”– we couldn’t help thinking about the critical omission that would seem to contradict the conclusion that European companies’ investment plans are unsupported and inadequate: Knowledge. While bank lending (and demand for loans) is undeniably weak, we would remind our faithful readers that investments in intellectual property are generally financed via equity– not debt. This makes intuitive sense, given that any bank would be more than reluctant to make a loan for something that is intangible. As a result, companies that invest heavily in knowledge tend to have higher levels of cash and less net debt on their balance sheets. In addition, when we actually give companies credit for the intellectual property assets on their books, we often see a significant increase in total assets (i.e. the basis for expected future profits).

DM EMEA as stated Assets

Knowledge Leaders

DM EMEA intangible-adjusted Assets

Knowledge Leaders

In aggregate, European companies have about 5% more in assets than the market sees on as-reported financial statements, once we make the necessary adjustments for intangible investments. Certain sectors clearly have a larger gap than others, with total assets for the Health Care sector “increasing” by 26% and total assets for Information Technology sector companies nearly 30% higher than the as stated figures.

Knowledge Leaders

All of this is the direct result of a consistent commitment to innovation and knowledge. Taking a closer look at the investment profile of these sectors, we see that Health Care and Information Technology companies each spend just under 20% of total sales on intangible activities like R&D, Advertising, and Firm-Specific Resources (i.e. human capital, brand development, codified information).

Knowledge Leaders

Knowledge Leaders

While loans may be lacking in a bank-dependent Europe, our process highlights that the important investments in equity-financed knowledge and innovation are happening, preparing these Knowledge Leaders for continued outperformance versus their peers.