Valuation of Private, Innovative Targets: Evidence from Cisco's Acquisitions

We study how the value paid for private, innovative targets is affected by its knowledge-related intangible assets. We use unique, hand collected data from Google patents for a large sample of private, innovative targets acquired by the serial acquirer - Cisco systems. By comparing targets acquired within the same year by an acquirer that represents the 'gold standard for M&A practices,' we minimize concerns that the premium paid is biased due to agency costs, asymmetric information, market timing, and acquirer desperation. First, we find that acquirers pay for the current stock of innovative assets possessed by the target as well as the growth opportunities these assets generate. Second, a target whose innovative portfolio complements that of the acquirer receives a significant premium: citations received from Cisco are valued approximately ten times the average citation. Third, acquirers pay for the human capital embedded in the target's employees. Finally, the target’s patents are proportional to the number of employees, which suggests that the production function for private, innovative firms may exhibit constant returns to scale. We are the first to study the valuation of knowledge-related intangible assets in mergers and acquisitions.