New Thoughts on Goodwill Impairment Testing

New thoughts on goodwill impairment testing by Marie Leone of CFO.com

Over two-thirds (68%) of U.S. public companies in the United States wrote down goodwill by taking impairment charges in 2008. Total charges were $260 billion according to a report issued by financial advisory firm Duff & Phelps and the Financial Executives Research Foundation. The report examined 2008 financial statements of nearly 6,000 publicly held companies.

As 2009 results are being filed it appears that goodwill write-downs have declined., says Greg Franceschi, who heads up the global financial reporting practice for Duff & Phelps. Since the worst of the financial crisis ended, company market values have increased and accordingly there are fewer goodwill write-offs.

However a new accounting wrinkle has surfaced related to goodwill impairments. At issue is whether companies should determine the fair value of a reporting unit — and thereby the value of the related goodwill — based on either the unit's equity value or its enterprise value. (In general, enterprise value is the sum of the fair value of debt and equity.)

The question was sparked by a December speech given by Evan Sussholz, an accounting fellow in the Office of the Chief Accountant at the Securities and Exchange Commission. In his speech, Sussholz suggested that in certain situations, using an enterprise-value measurement may provide a more economically accurate picture of the reporting unit. His suggestion left preparers and auditors clamoring for a clarification, as companies have historically applied the equity-value approach to impairment testing, says PricewaterhouseCoopers partner Larry Dodyk.

In response, the Financial Accounting Standards Board and the American Institute of Certified Public Accountants have launched efforts to figure out whether additional guidance on the subject is needed. FASB's emerging issues task force is slated to start discussing potential guidance during the second half of the year, while the AICPA is currently working on completing a practice aid, which is a sort of unofficial manual that discusses best practices and concepts that auditors and preparers may want to apply.

Under U.S. GAAP, companies must perform a goodwill impairment test at least once a year to determine if the current value of an acquired reporting unit is worth more or less than its original price. The test is a two-step process in which the company must first compare the fair value of a reporting unit with its original price — the amount the company carries on its books. If the book value exceeds the fair value, then the asset is impaired and a second step is required to measure the amount of the impairment. If the book value is lower than the unit's fair value, then the asset passes the test and nothing more is required.

The confusion over whether to use equity value or enterprise value stems from the seemingly straightforward first step of the test, because the accounting rule is unclear. Sussholz said that originally, the SEC didn't believe the selection of one approach over the other would affect the test outcome. However, since taking a closer look at the practical implications, SEC staffers have acknowledged one unanticipated situation that is a potential problem: when the book value of a reporting unit measured at the equity level is negative.

Intuitively, it might seem that a negative book value would mean a reporting unit is on the verge of bankruptcy, but that may not be the case. Dodyk explains that a single reporting-unit company, for example, may have negative shareholders' equity as a result of unrecognized assets (such as intangibles) that have significant value but don't figure into the equity equation. Heavy borrowing for a leveraged buyout could also send shareholders' equity into negative territory.

Consider what happens in an equity-value impairment test when a reporting unit's book value is negative. By definition, the fair value of common equity cannot be less than zero, because the equity is essentially a call on the company's operations. That means the fair value of a reporting unit measured at the equity level would always be greater than a negative book value, and therefore always pass step one of the impairment test. That would be the case even if significant goodwill exists and the underlying operations of the reporting unit "may be deteriorating," asserted Sussholz.

On the other hand, says Franceschi, testing for impairment at the enterprise level would include the reporting unit's debt burden, providing what Sussholz claimed was a more accurate picture of the company's financial health. To be sure, his speech opened up the possibility that another testing approach may be permitted or required.

Franceschi doesn't believe the additional guidance will cause a significant increase or decrease in goodwill write-offs. But it may require companies to rethink valuation models and approaches, especially if the guidance recommends that companies use more judgment when determining a reporting unit's fair value. "For valuation issues, you can never have something that says, 'This is the way to do it, and the only way to do it,'" he says. "There may be multiple approaches one needs to consider."

Another concern with tinkering with Topic 350 is that it may spark other changes. "Once you open the rules to the goodwill impairment test, you never know where it is going to go," says Dodyk.

SEC Comment Letters--In Your Mailbox Soon?

The accounting firm Crowe Horwath has published an article Recent Trends in SEC Comment Letters--Reproduced in its entirety below.

In December 2008, the Securities and Exchange Commission (SEC) staff indicated at the American Institute of Certified Public Accountants’ (AICPA) National Conference on Current SEC and PCAOB Developments that they would be conducting targeted reviews of fair value, other-than-temporary impairment (OTTI) of securities, and other asset impairments. As a result, several recent examples of SEC staff comment letters on periodic filings (Form 10-Qs and 10-Ks) have a clear focus on these issues.

Following are some general themes present in comment letters from the SEC staff on recent filings that might be helpful for registrants to consider as they prepare periodic filings. Management should carefully review their company's accounting policies as well as related financial statement and management’s discussion and analysis (MD&A) disclosures related to these issues.

Accounting
OTTI of Securities
The SEC has:

• Asked registrants to justify why securities with fair values significantly below cost are not considered to be OTTI.
• For securities with ratings of "default" or "speculative," the SEC has asked how management determined that an adverse change in cash flows had not occurred.
• Challenged registrants on whether the losses for sales of securities after a period end should have been recognized in the prior period.
• Asked registrants to provide specific information about securities with significant unrealized losses.
• Requested information includes the specific issuer and name of each security; type of underlying collateral, credit rating, severity, and duration of the unrealized loss; and how the financial condition and near-term prospects of the issuer were considered when determining that no OTTI was present.

Securities/Other
The SEC has asked registrants to:

• Provide implied discount rates used in determining fair value of securities when using Level 3 inputs (in accordance with the guidance in Financial Accounting Standards Board Staff Position 157-3 (FSP FAS 157-3), “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active,” and FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly”).
• Reconcile the cash flows used to determine fair value with the cash flows used to assess OTTI.
  Indicate the systems and controls used to validate prices received from third parties when valuing securities.

Goodwill and Other Intangible Assets
The SEC has commented on:

• Implied control premiums used to determine fair value of reporting units for purposes of step one of goodwill impairment tests. Assumptions used to determine fair value must be supportable and should not contradict observable data about recent transactions.
• The lack of support for a reasonable period in the context of determining market capitalization of a reporting unit.
• The lack of support for assumptions used when determining the fair value of an intangible asset – for example, when a multiperiod earnings approach has been used.

Presentation and Disclosure

Loans and the Allowance for Loan Losses
The SEC has:

• Asked registrants to consider more disaggregated disclosure about loan portfolios – for example, providing disclosures by exposure to subprime, alt A-paper, or other relatively high-risk loans.
• Commented on disclosing reasons for changes (or lack thereof) in general loan reserves considering changes in credit risk.
• Commented on presenting the basis for each risk category and the method for determining the loss factor applied to each category. It has asked companies to specifically identify how historical loss trends were adjusted based on current factors.
• Asked registrants to explain reasons for directional inconsistencies in loan-loss allowances – for example, when impaired loans increased but specifically identified reserves decreased.

Securities
The SEC has requested:

• More disclosure of reasons for transfers into and out of the Level 3 category and more robust discussion of how fair value was determined when classified as Level 3.
• Support for securities being presented as Level 2 that appear to require Level 3 classification based on other disclosures.

www.crowehorwath.com

Push Down Accounting

The Controller's Roundtable is a web site with a vast array of information, discussions and applications that are of great use to both reporting and operations people.

They recently compiled the results of a discussion group on push down accounting. For those not familiar with this term, when a company completes a share acquisition, they will end up paying more that the acquired company's book value for assets acquired and liabilities assumed.

Companies sometimes “push down” the fair value to the acquired subsidiary. On consolidation, nothing changes. The changes affect internal reporting and segment reporting, where asset values are sometimes used for management accounting purposes in calculating asset and earnings based ratios. The additional depreciation or amortization of hard assets and intangibles would affect the subsidiary's earnings.

On the question of when push down accounting is used, the following was observed from a recent Controller's Roundtable discussion:

- 72% pushed down purchase price allocations (including goodwill, intangibles, and fixed asset fair value changes) to acquired businesses.

- 22% said they generally push down the purchase price allocations in most cases, but this could change depending on whether it's a foreign or domestic acquisition.

Check out the Controllers Roundtable.

Got Goodwill? Part 21

A few more large goodwill impairments:

HONG KONG -- Ping An Insurance (Group) Co. of China Ltd. an impairment charge of 22.79 billion yuan (US$3.33 billion) on the company's stake in Fortis NV.

First Data Corp. reported goodwill impairment charge of $3.2 billion which resulted from the decline in economic conditions which drove a change in First Data's management projections and an increase in discount rates reflected in First Data's fair value estimates.

MGM MIRAGE reported goodwill and indefinite-lived intangible asset impairment charges of $1.2 billion as a result of global economic conditions and market trends--and that these trends have continued into the first quarter of 2009.

Rite Aid goodwill impairment, store impairment and deferred tax asset write-down that totaled $2.2 billion. The goodwill impairment charge is related to the July 2007 Brooks Eckerd acquisition.

Oshkosh Corporation anticipates recording non-cash impairment charges of $1.2 - $1.5 billion for the write-down of goodwill and other indefinite-lived intangible assets in the second quarter of driven by the short-term economic environment.

Macy's Impairs $5 Billion

Macy's Inc,, the U.S. based department store chain has recorded a goodwill impairment charge of $5.4 billion in the fourth quarter. The impairment charge follows a sharp decline in the company's market capitalization.

Macy's market cap today is about $4 billion, down from about $20 billion at its peak in 2007.

Macy’s had previosuly warned of the impairment charge and said the estimate is subject to further adjustment when it completes its calculations in the first quarter of 2009.

The non-cash write-down should not affect Macy’s financing covenants and accordingly will not cause defaults in bank credit agreements or bond indentures.

Macy’s reported operating income of $1 billion but the impairment charge brings their fiscal 2008 loss to $4.4 billion.

The goodwill arose on Macys' 2005 acquisition of May Co., the economic downturn and the decline in market capitalization.

Got Goodwill? Part 20: More on Market Cap

Following is a good article form the Globe and Mail on how market cap and goodwill are related. The profiled company files under Canadian GAAP, which is the same as U.S. GAAP in the area of goodwill impairment calculations.

By late 2008, David Adams could tell with one glance at his books that the market had handed him a problem.

The chief financial officer at Groupe Aeroplan Inc. was carrying almost $3-billion in goodwill on the flight-reward company's balance sheet, most of it residue from its 2005 spinoff from ACE Aviation Holdings Inc. But the entire market capitalization of Aeroplan's stock, which had been close to $5-billion in early January, had tumbled to $1.3-billion by late November. According to the market, the entire company was worth less than half of the value of its goodwill alone.

Accounting rules and regulatory directives were crystal clear: The discrepancy between the market value and the goodwill was a flashing red warning signal that the goodwill was probably no longer worth what Aeroplan's books said it was. The company was compelled to run an impairment test. The result: a $1.16-billion writedown against earnings, which the company reported last month.

"It was actually pretty simple," Mr. Adams said. "The securities regulators are driving the bus on this."

Aeroplan is hardly alone: Plunging asset values, slumping earnings prospects, rising borrowing costs and a key 2002 accounting change have left an unprecedented amount of increasingly hard-to-justify goodwill on corporate balance sheets, prompting Canadian and U.S. regulators to remind companies to take a hard look at their goodwill. The result has been a wave of big-money writedowns that might still be in its early stages.

A recent report from Desjardins Securities showed that companies on the S&P/TSX composite index had a combined $168-billion of goodwill on their balance sheets at the end of the third quarter. Since then, TSX companies have announced at least $13-billion in goodwill writedowns, including charges of more than $1-billion each at Aeroplan, Nortel Networks Corp., CanWest Global Communications Corp., Great-West Lifeco Inc. and Gerdau Ameristeel Corp.

Financial executives argue that the writedowns are non-cash charges that don't reflect on a company's operations. But analysts warn that the implications may be more severe.

By definition, a goodwill writedown reflects a permanent impairment in an asset's future cash flow potential, which could imply a risk to dividends. Analysts warn that the writedown of assets may put at risk debt covenants and hurt a company's ability to raise funds, and that it also amounts to an admission by management that it overpaid to acquire assets.

"I would argue that if you're holding the stock [of a company with high exposure to goodwill], you should be concerned about it," said Peter Gibson, vice-chairman and strategist at Desjardins.

While goodwill is a fuzzy concept, in strictly balance sheet terms it represents the gap between the fair value of an asset and the price its owner paid to acquire it. When a company acquires assets at a price above their fair value, the excess is recorded as goodwill - the implication being that the asset's prospects for future growth in cash generation justify the premium paid, and thus have value in themselves.

Goodwill writedowns typically accelerate during bear markets, as companies adjust their assessment of the cash-generating potential of assets purchased during better times to reflect the new, much less rose-coloured reality. But this time around, goodwill charges are headed for unprecedented heights, because regulators changed the rules governing the accounting for goodwill since the last bear market.

Before 2002, companies were required to amortize goodwill on their books annually, so it would eventually shrink to nothing over time. In 2002, U.S. and Canadian accounting regulators decided to allow companies to carry goodwill perpetually on their balance sheets, but required them to run an annual test to determine if there were any underlying change in valuations that had undermined those goodwill estimates, known as a goodwill impairment.

If warning indicators crop up in between annual impairment tests - such as a sharp drop in market value, or a serious deterioration in business conditions - regulators have directed companies to test immediately to see if a goodwill writedown is required.

During the downturn of 2001, before the rule change, goodwill writedowns in the U.S. totalled $51-billion (U.S.). That number has already been easily eclipsed in this recession: Two companies alone - Sprint Nextel Corp. and Courier Corp. - combined for $54-billion in goodwill writedowns.

"I'm not sure there is any historical precedent, " said Karen Parsons, an accountant and business adviser at consulting firm Grant Thornton LLP in Toronto. "This is really the first test."

Compounding the rule change is the fact that during the 2002-07 bull market, companies routinely paid big premiums for acquisitions. Now, many of the growth assumptions that justified those premiums have been turned on their heads, as market values collapsed and economic prospects withered.

This has left many companies carrying goodwill on their books that hasn't been depreciating and, over the space of a few months, has rapidly become impossible to justify.

"If you made an acquisition in the past two or three years and you expected that business to keep growing, or if you paid with your own shares and they have gone down, that could indicate an impairment of goodwill," Ms. Parsons said.

Anthony Scilipoti, an analyst at Veritas Investment Research Corp., thinks resource-based companies look especially exposed to goodwill writedowns because they bought assets in the past few years based on high assumptions for future commodity prices.

Still, he said the current depressed stock prices might already have priced in the risk of goodwill writedowns.

"Very often, it is a lagging indicator," Mr. Scilipoti said. "The stock price has already gotten hit because the underlying business fundamentals have turned sour. Then you question [whether] the goodwill is impaired."

Given the already discounted values for stocks in the markets, some experts feel that companies may be better off absorbing goodwill writedowns now, cleaning up their balance sheets and better positioning themselves for the next upturn - especially since the 2002 removal of the amortization rule for goodwill may have made writedowns ultimately unavoidable.

"At some point in time, most organizations are going to be faced with a goodwill impairment," Aeroplan's Mr. Adams said. "You may as well just get it out of the way."

THE GREAT DEBATE
Canadian and U.S. securities regulators recently reminded companies that they must consider their sinking stock prices as an indicator of a potential impairment of goodwill - a directive that may be accelerating the number and size of goodwill writedowns. Much like the mark-to-market question surrounding troubled mortgage-backed securities in the banking sector, this regulatory position has sparked a debate: Is it fair?

"That's the million-dollar question," said accounting expert Karen Parsons of Grant Thornton LLP. "One viewpoint is that [the market value] is the fair value today, there's an impairment, and if you don't take it, you're not reporting appropriate information to the market.

"On the other end of the spectrum, there are people who would say this is just a very unusual circumstance, it's not an indicator of the market on the long term, and we shouldn't be putting as much emphasis on it," Ms. Parsons said.

Wayne Brownlee, chief financial officer at Potash Corp. of Saskatchewan, said one big concern for companies is that goodwill tests triggered by slumping markets may be feeding a vicious circle.

"It's a continual spiralling down or self-fulfilling prophesy on valuation," he said. "The more you write down, the more the earnings come down, and you have to go back and reassess [goodwill] every quarter. It just keeps pulling [the stock price] down and down."

Some experts, however, argue that the market's pricing of many of these stocks already reflects investors' belief that a goodwill impairment exists - that the business case for the assets has deteriorated sufficiently to have blasted a hole in assumptions about future growth.

"The investor has already decided that an impairment exists. The market is making a determination of value," said Richard Crosson, national head of the business valuation group at Ernst & Young LLP.

"You would need more persuasive reasons [to avoid taking a goodwill writedown] than simply the market is irrational."
DAVID PARKINSON from Globe and Mail March 17, 2009

Got Goodwill? Part 19: The Horror

Impairments are continuing to carve up balance sheets as 2008 earnings are reported.

It’s always interesting (at least to us financial reporting geeks?) how companies talk about huge impairment charges. Usually the talk is around “non-cash charges”, implying that an impairment charge is meaningless, so let’s drive on.

However the CFO of Energy Future Holdings recently was a bit more talkative oon the subject , saying he was “horrified" to make a large impairment charge.

Paul Keglevic, EFH's new chief financial officer said the above about writing off $9-billion in goodwill. Other charges include $500 million related to the company's trade name.

Keglevic also said:

• The number $9 billion "doesn't roll off my lips."
• When private equity investors bought the company, they calculated it was worth $48 billion, including $23 billion for goodwill and intangibles.
• The goodwill value has declined because the value of other electricity companies has dropped as the stock markets fell and because the value of EFH debt is down.
• The decline is on paper; EFH isn't in financial trouble
• The value of the company is only interesting if EFH owners want to sell, sort of like the value of a home.
• The good news is we aren't trying to sell the company today.
• He is not worried about EFH's cash flow. They will have enough cash flow to pay off the $40 billion in debt taken on to buy the company.
• They expect the recession and decline in the stock market to prompt other companies to take similar goodwill charges
• "This will be the biggest year of goodwill impairment this country has ever seen,"

Other recent big impairment charges:

Novelis $1.5 billion
Gerdau Ameristeel $1.2 billion
Sprint Nextel $1 billion
Kinross Gold $994 million
Barrick Gold $773 million
Chemtura $665 million
Ingram Micro $659 million
Nalco $544 million
Chiquita Brands $374 million

Reasons for impairment cited include:

• Increased market cost of capital, due primarily to the significant deterioration in the capital markets during the third fiscal quarter, when market cost of debt required in impairment calculations is significantly higher than the interest rates on existing debt
• Decline in market capitalization for the issuer and other industry participants
• Impact of the global recession on near-term operating forecasts.
• Closure of underperforming units
  
  

Got Goodwill? Part 20: Impairment and Share Price

Royal Bank of Scotland just announced around 20 billion pounds in goodwill writedowns. Interesting to watch their share price--when they made the final announcement their share price actually rose about 30%. That's not the whole story though. They first warned the markets about large impending losses a few weeks ago and their share price dropped about 90%. When companies announce impairments, sometimes the impairment is already priced into their share price, other times it is is not.

Fifth Third Bancorp shares dropped 29% after announcing close to a billion in impairment. However the shares were partially pushed lower by their CEO's comments about the rest of the year.

Regions Financial shares fell 24% after a $6 billion in goodwill writedowns. Hartford Financial shares were down 16% after a $2 billion goodwill hit. Companies usually argue that goodwill impairment has no impact and it is almost always described as a non-cash charge. Stock markets usually anticipate the write-down. However companies need to watch their lending covenants. Some companies may be downgraded after announcing impairments since impairments reduce assets, potentially causing problems with lenders and rating agencies. Moody's put Weyerhaueser under review after a goodwill impairment charge of close to $1 billion, stating that goodwill impairment charges "may reduce covenant headroom" under their credit facilities. This means that Moodys thinks that Weyerhauser is less credit-worthy because it has fewer assets on its balance sheet to make it worthy of receiving more lending.

Got Goodwill? Part 18 Shaving Down Goodwill?

Some accounting sport has been had in forecasting which companies might announce goodwill impairment. Ccompanies where goodwill is 15% or greater proportion of total assets and where that ratio is greater than their industry median are likely candidates.

Also consider rising ratios of:

• accounts receivable to sales
• accumulated depreciation to plant, property and equipment
• underfunded pension benefits to liabilities

Multiple amended securities filings also seem to be a predictor.

The above ratios shouldn't vary much in companies in control of their financial position. For example the ratio of receivables to sales, for example, ought to be pretty consistent quarter over quarter. When ratios start changing for the worse, say a worsening over 2-3 years it may be an indicator of near-term problems.

Procter & Gamble has $60-billion of goodwill and a total of $90-billion of goodwill and intangibles. Some have identified their goodwill as ripe for a write-down. P&G bought Gillette for $57 billion in 2005 and put goodwill of $37-billion created from the merger on its balance sheet. Warren Buffett called it a "dream deal." Gillete had the world's largest share of shaving products prior to being bought by P&G.

P&G's goodwill is spread across the following businesses:

Beauty: $17 billion
Grooming: $25 billion
Health Care: $9 billion
Snacks, Coffee and Pet Care: $2 billion
Fabric Care and Home Care: $ billion
Baby Care and Family Care: $2 billion

It will be interesting to watch P&G for goodwill impairment--interesting because their products are generally not considered luxury products and may not be affected by current economic malaise. Their shares were at a 52 week high of $73 before last fall and are sitting at about $50 now. Their market cap is about $150 billion, more than twice their book equity.

People who watch the ratios noted above are saying that other companies to watch may be biotech Amgen which has been on a buying spree. Monsanto, Kraft, and CVS Caremark, all of which have done big mergers and acquisitions over the past few years. Also eBay and Transocean.

With information from Barron's


Malcolm McKay

Got Goodwill? Part 17: SEC Views on Impairment

SEC Speech Shares Views on Impairment

At the December AICPA/SEC/PCAOB Conference, SEC staff talked a lot about goodwill in a number of speeches.

Key points:

Thorough disclosures about critical accounting estimates related to goodwill impairment testing are required.

Disclose:

• How goodwill reporting units are determined, including any aggregation of reporting units,
• Methodology used to determine the fair value of reporting units (including the weighting of each approach in cases in which multiple approaches are used)
• Date or range of dates used to determine market capitalization
• Evidence used to assess the reasonableness of an implied control premium (difference between the fair value of the reporting units and the enterprise’s market capitalization)
• Key assumptions and sensitivity analysis related to those key assumptions.
• Early warning disclosures in MD&A if it is reasonable to expect a material impairment in a future period.

Beware

SEC speakers said staff will ask questions about the adequacy of disclosures if there are indicators of impairment but no impairment charge.

SEC staff warned that assumptions underlying impairment analyses should be consistent with other accounting measurements and non financial disclosures in their SEC filings.

Goodwill Impairment Calculations

Reconciliation to market capitalization—a key element of the analysis is to reconcile the aggregate fair values of goodwill reporting units to market capitalization.

SEC staff does not expect a registrant to determine its market capitalization using a point in time market price as of the date of its goodwill impairment assessment.

Instead, consider recent trends in its stock price over a reasonable period.

Given recent stock price volatility, SEC staff would likely not expect enterprise market capitalization to be calculated solely based on stock price fluctuations on or around the goodwill impairment assessment date.

They warned not to ignore a recent drop in market capitalization.

The SEC does not apply a bright-line test to analyzing control premiums. They say that application of judgment can result in a range of reasonably possible control premiums.

Evidence should support the judgments that the implied control premium is reasonable, and support should be in the form of contemporaneous documentation, including any identified transactions.

It is not acceptable to use a “rule of thumb” to support the implied control premium.

The amount of documentation supporting the implied control premium to increase as the control premium increases.

A different speech revealed:

Indicators of Impairment According to the SEC

• Recent operating losses at the reporting unit level
• Downward revisions to forecasts
• Decline in enterprise market capitalization below book value
• Restructuring actions or plans
• Industry trends.

Malcolm McKay

Got Goodwill? Part 16: Billions Gone from Vacation, Car Rental, Communication, Insurance Balance Sheets

Wyndham Worldwide one of the world's largest hospitality companies recorded non-cash goodwill impairment charge of $1.3 billion vacation time share business related to adverse financial markets.

Lloyds Banking Group announced £7bn for 2008 impairments in the HBOS corporate banking business. They said it was only £1.6bn higher than it had expected when it issued its shareholder circular on the takeover at the HBOS business last year. It said that the "acceleration in the deterioration in the economy" and a "more conservative provisioning methodology consistent with that used by Lloyds" caused the higher impairment.

Avis Budget announced an impairment charge of $1.3 billion given “the significant decline in the company’s equity market value over the last several months, as well as soft economic conditions and financial market disruptions that have increased the cost of capital for many corporations.”

Charter Communications announced that it expects to record an impairment charge of $1.5 billion. Unlike other “good news” announcements emphasizing investor value, they said that they will restructure debt under bankruptcy protection, completely wiping out shareholders.

Malcolm McKay

Got Goodwill? Part 15: It’s All in the Timing

CBS announced a goodwill impairment, then got sued.

CBS issued a press release on October 10, 2008 announcing that it would to incur an impairment charge of approximately $14 Billion in the third quarter of 2008.

After the announcement, CBS common shares declined from $10.14 to $8.10. CBS closed this week at $5.81.

A more recent press release talks about an investigation of the timing of the CBS announcement and how alleged damages might have resulted to shareholders of various CBS plans.

The complaint alleges that CBS violated securities regulations by making materially false and misleading statements about its financial condition and operating results.

The complaint is a class action on behalf of former or current employee or members of CBS investment plans or profit sharing retirement plans or individuals who purchased CBS stock in one of those plans during the periods February 26, 2008 to October 10, 2008.

The complaint alleges that:

• CBS failed to disclose that ‘adverse market conditions had materially impaired CBS's operations, expected cash flows and the value of its intangible assets, including goodwill'
• CBS's goodwill and intangible assets were materially overstated'
• CBS' positive statements that it 'clearly has the right broad range of assets to produce outstanding free cash flow quarter after quarter, year after year,' were materially false and misleading and without reasonable basis.

You can have a look at a graph of CBS share price in 2008 here.

Read the complaint here.

Malcolm McKay

Got Goodwill? Part 14: Rio Tinto Impairs $8 Billion

Rio Tinto has reported an asset impairment charge of $8.4 billion, mostly attributed to a write-down of its aluminum business, which recorded a $7.9 billion write down.

The aluminum division reported earnings of $1.18 billion, reduced from $2.8 billion as a result of higher costs and adverse exchange rate movements.

Corporate earnings were a record of $10.3 billion, up 38 per cent from the 2007 at $7.4 billion.

The company is now focusing on paying down its $40 billion debt from its $42.5 billion takeover of Alcan in 2007. The company previously stated that the debt dragging on the company. "We are comfortable ... with our financial position, we are confident that our debt position is manageable," they previously stated. "We have $9 billion of debt which is due for repayment in October 2009, we don't see any need to issue equity to meet that. In fact, we currently have available unused credit facilities of almost $7 billion."

Today Rio announced that Chinalco will inject equity totaling $US19.5 billion.

Malcolm McKay

Goodwill Impairment Hall of Fame -- the List

Following is the list of impairments $100 million or greater noted to date. They are generally all before-tax numbers and all occurred in 2008 unless indicated otherwise. Some impairment amounts for non-goodwill assets may be included.

Sprint Nextel $29 billion (in 2007)
Time Warner $25 billion
CBS $14 Billion
Regions Financial $6 billion
Alcatel $5 billion
Motorola $3.5 billion
BHP $3.36 billion
Supervalu $3.3 billion
Bank of America $2.3 billion
Sovereign Bancorp $1.6 billion
Marathon Oil $1.4 billion
United Rentals $1.1 billion
OfficeMax $1 billion
Sandisk $1 billion
Freeport-McMoRan $13.1-billion
Royal Philips Electronics $1.7 billion
Marathon Oil $1.4 billion.
eBay $1.39 billion (2007)
Cadence Design Systems Inc $1.36 billion
Avnet $1.317 billion
Hercules Offshore $1.2 billion
XL Capital $990 million
Tellabs $988 million
Dow $978 million
Fifth Third Bancorp $965 million
Fifth Third Bancorp $965 million
Weyerhaeuser $827 million
Capital One $811 million
ProLogis $811 million
Charles River $700 Million
JDS Uniphase Corp $692 million
RF Micro Devices $673.0 million to
Morgan Stanley $673 million
RF Micro Devices $673 million
Freeport-McMoRan $6.0 billion
Domtar $591 million
Colonial Bancorp $575 million
Vishay Intertechnology $565 million
Citigroup $563 million
ON Semiconductor $557 million
UPS $548 million
Nalco $544 million
Lear $530 million
Yahoo! $488 million
Loews $482 million
KeyCorp $465 million
KeyCorp $465 million
Synovus $463 million
Micron $463 million
Belden $461 million
GMAC $455 million
Cablevision $450 million
Ciba $448 million
International Paper $438 million
Mueller Water Products, Inc. $400 million
E.ON AG $4.29 billion
Mylan $385 million
Tailwind Financial Inc. $380 million
Electronic Arts $368 million
Cytec Industries $358 million
Cytec Industries $358 million
Lubrizol $356 million
Zions Bancorp $350 million
Quantum $350 million
Pepsi Bottling Group $336 million
Brightpoint $325.9 million
Brightpoint $325.9 million
Harman International $325 million
Chemtura $320 million
Jabil Circuit $317 million
Powerwave Technologies, $315 million
MPS Group $303 million
Royal Philips Electronics $300 million
B/E Aerospace $300 million
Citizens Republic Bancorp $288 million
KLA-Tencor $272 million
Applied Micro Circuits $264.1 million
Applied Micro Circuits $264 million
Guaranty Bancorp $250 million
iBasis $249 million
iBasis $249 million
Benchmark Electronics $247 million
Affymetrix $239 million
South Financial $237.6 million
The South Financial $237 million
Lattice Semiconductor $223 million
Macrovision Solutions $208.3 million
Headwaters $205 million
Fairchild $203 million
Fairchild Semiconductor $203 million
Western Digital $200 million
Ford $2.7 billion
Kinder Morgan $2.3 billion
Webster Financial $189 million
Complete Production Services $178 million
Comsys (up to) $175 million
Comsys IT Partners up to $175 million
Polyone $170 million
Dick's Sporting Goods about $165-$180 million
Jazz Air Income Fund $153 million
Piper Jaffray $140 million
Kforce $129.4 million
First State Bancorporation $127 million
THQ $118.1 million
Colonial Properties $116 million
Hanmi Financial $107 million
LeCroy $105 million
Web.com $103 million
Sara Lee $100 million
Ameristar Casinos $100 million
Canfor (TSX: CFP) $100 million

Some of the conversions to $US may be off somewhat.

Got Goodwill? Part 11: Bad News

News Corp reported writedown of $8.4 billion on Dow Jones and other assets. The impairment charge mainly consisted of a $4.6 billion writedown of the value of its broadcast licenses and a $3.6 billion writedown of goodwill in its newspaper and information services group.

News Corp purchased Dow Jones, the publisher of the Wall Street Journal, in 2007 for an estimated $5.6 billion. It did not say how much of the writedown related to that acquisition.

News Corp's market cap is about $18 billion.

Chairman Rupert Murdoch: "While we anticipated a weakening, the downturn is more severe and likely longer lasting than previously thought."

Got Goodwill? Part 10: Time Warner in the Impairment Hall of Fame

Boom times generate cash. Cash generates mergers and acquisitions. Mergers and acquisitions generate goodwill.

Recent market crashes have caused companies and their auditors to look closely at the value of goodwill and intangibles.

Recent additions to the “Impairment Hall of Fame” (see earlier posts for previous additions):

Sprint Nextel $29 billion (in 2007)
Time Warner $25 billion
Regions Financial $6 billion
Alcatel $5 billion (Euro $3.91 billion)
BHP $3.36 billion
Supervalu $3.3 billion
Motorola $3.5 billion (including tax valuation charges)
Bank of America $2.3 billion
Sovereign Bancorp $1.6 billion
Marathon Oil $1.4 billion
United Rentals $1.1 billion
OfficeMax $1 billion
Sandisk $1 billion
Dow $978 million (restructuring, goodwill impairment and other matters)
Capital One $811 million
Colonial Bancorp $575 million
Citigroup $563 million
UPS $548 million
Nalco $544 million
GMAC $455 million
International Paper $438 million (possibly an additional $1.3 Billion)
Yahoo!$488 million
Synovus $463 million
Micron $463 million
Mylan $385 million
Cytec Industries $358 million
Zions Bancorp $350 million
Quantum $350 million
Chemtura $320 million
Applied Micro Circuits $264 million
The South Financial $237 million
Fairchild $203 million
Western Digital $200 million
Webster Financial $189 million
Comsys (up to) $175 million
Piper Jaffray $140 million
First State Bancorporation $127 million
Colonial Properties $116 million
Sara Lee $100 million
Central Pacific Financial $94 million
H.B. Fuller $86 million
Convergys $61 million
Diebold $46 million

Goodwill is an intangible asset that represents value in a combined post-merger company due to factors other than customers, brands, trade marks, technology and other intangible assets that accounting rules require companies to recognize. According to the Economist, goodwill and other intangibles recoded by S&P 500 companies totals $2.6 trillion, or 10% of their total assets.

Most investors consider goodwill impairment to be old news at the time it is announced. Share values are often not impacted by announcements of goodwill impairment. This is generally thought to be because either: a) markets have already priced impairment into share prices, or b) since share prices are ultimately a factor of the discounted value of future cash flows from operations, that impairments do not affect cash flows and accordingly do not impact share prices. Analysts ignore impairments and other unusual earnings line items when normalizing historical numbers to forecast future earnings. An exception to this is when investors are surprised by the impairment news—if the markets had no reason to believe that a company was underperforming and the bad news was not anticipated.

Time Warner’s market capitalization was about 60-70% of its book value—a sure sign of goodwill impairment. Its market capitalization was less than its total goodwill of over $40 billion—the goodwill on the financials was worth more than Time Warner as a whole.

Is this an acknowledgement by Time Warner that it previously overpaid for acquisitions?. Perhaps based on today’s depressed market they overpaid, but they didn’t buy in this market and might no have paid the same if they bought today. But acquisitions are always supported by due diligence and forward-looking valuations. Goodwill impairment calculations are backward-looking and hindsight is always 20/20.

Around 200 U.S. of the largest companies have market cap less than their goodwill and intangibles according to Bloomberg., which states that combined, these companies had goodwill and intangibles of over $808 billion. And about $400 billion of this is goodwill.

Watch for more impairments.

Got Goodwill? Part 9 Impairment Hall of Fame (continued)

Recently anounced goodwill impairment charges:

Valero Energy Corp. $4.1 billion

Flextronics $5.9 billion

B/E Aerospace, Inc $300 million

U.S. Airways $622-million

Boston Scientific Corp. $2.7 billion

Colonial BancGroup $575 million

Banner Corp., $71.1 million

Quantum Corp. $350 million

Applied Micro Circuits $264 million

Lattice Semiconductor $225 million

These are in addition to the previous charges announced as noted here.

Got Goodwill? Part 8: Symantec has $7 Billion Impairment Virus

Security software maker Symantec Corp. took a $7 billion goodwill impairment charge in its December 2008 third quarter results. Symantec kept $5-billlion of goodwill on its books. About $8-billion of their goodwill before the write-down came from their acquisition of Veritas for $13.5-billion in 2004.

They completed an interim impairment analysis, meaning that they checked for impairment before being required to do so by their internal policy on testing impairment.

Symantec stated” The GAAP net loss for the third quarter of fiscal year 2009 includes a non-cash goodwill impairment charge of approximately $7 billion. Based on a combination of factors, including the current economic environment and a decline in our market capitalization, we concluded that there were sufficient indicators to require us to perform an interim goodwill impairment analysis. We have not completed the goodwill impairment analysis and expect to finalize it during the fourth quarter of fiscal year 2009. We may make an adjustment to this charge when the goodwill impairment analysis is completed.”

Got Goodwill? - Part 7 - Latest Impairment: Celestica

Celestica announced its Q4 earnings this week and disclosed that it has written off all of its remaining goodwill. Their explanation from their financial statement notes is set out below. It’s interesting from the perspective of how they describe the mechanics of the write-down:

We are required to evaluate goodwill annually or whenever events or changes in circumstances indicate that we may not recover the carrying amount. Absent any triggering events during the year, we conduct our goodwill assessment in the fourth quarter of the year to correspond with our planning cycle. We test impairment, using the two-step method, at the reporting unit level by comparing the reporting unit’s carrying amount to its fair value. To the extent a reporting unit’s carrying amount exceeds its fair value, we may have an impairment of goodwill. All of our goodwill is allocated to our Asia reporting unit.

During the fourth quarter of 2008, we performed our annual goodwill impairment assessment. Our goodwill balance prior to the impairment charge was $850.5 and was established primarily as a result of an acquisition in 2001. We completed our step one analysis using a combination of valuation approaches including a market capitalization approach, multiples approach and discounted cash flow. The market capitalization approach uses our publicly traded stock price to determine fair value. The multiples approach uses comparable market multiples to arrive at a fair value and the discounted cash flow method uses revenue and expense projections and risk-adjusted discount rates. The process of determining fair value is subjective and requires management to exercise a significant amount of judgment in determining future growth rates, discount and tax rates and other factors. The current economic environment has impacted our ability to forecast future demand and has in turn resulted in our use of higher discount rates, reflecting the risk and uncertainty in current markets. The results of our step one analysis indicated potential impairment in our Asia reporting unit, which was corroborated by a combination of factors including a significant and sustained decline in our market capitalization, which is significantly below our book value, and the deteriorating macro environment, which has resulted in a decline in expected future demand. We therefore performed the second step of the goodwill impairment assessment to quantify the amount of impairment. This involved calculating the implied fair value of goodwill, determined in a manner similar to a purchase price allocation, and comparing the residual amount to the carrying amount of goodwill. Based on our analysis incorporating the declining market capitalization in 2008, as well as the significant end market deterioration and economic uncertainties impacting expected future demand, we concluded that the entire goodwill balance of $850.5 was impaired. The goodwill impairment charge is non-cash in nature and does not affect our liquidity, cash flows from operating activities, or our compliance with debt covenants. The goodwill impairment charge is not deductible for income tax purposes and, therefore, we have not recorded a corresponding tax benefit in 2008.

Got Goodwill? Part 6—European Impairment Watch

European companies that adopted IFRS goodwill accounting may have their first severe year of reckoning with goodwill impairment charges this year. A few big companies will be on watch for writedowns. Vivendi has already indicated they will take a write down on its €22-billion of goodwill.

As with other markets around the world, European markets have been beaten up and lost significant value over the last six months or so.

Total goodwill reported for companies included in the Dow Jones Stoxx 600 index is about €1 trillion. This compares with a total market capitalization of around €3.5 – 4 trillion for the index., The Stoxx index represents large, mid and small capitalization companies across 18 countries of the European region: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the UK.

France Télécom (€32-billion), Vivendi (€22-billion) and Sanofi-Aventis (€43-billion) account for over 10 percent of French goodwill.

In France alone, the total amount of goodwill for companies included in the SBF 120 stock-market index reached €350 billion at the end of June, as companies have spent heavily on acquisitions over the past few years. The overall goodwill for SBF 120-listed companies compares with a total market capitalization of €841.5 billion for that index at Friday's close. The SBF 120 is a French stock market index. The index is based on the 120 most actively traded stocks listed on the Paris Bourse Paris Bourse (now Euronext Paris). The index includes all 40 stocks in the CAC 40 index (a capitalization-weighted measure of the 40 highest market caps on Euronext Paris, plus a selection of 80 additional mid-cap stocks listed on Euronext Paris.

IFRS rules require an annual impairment test. In addition, companies must test goodwill if other indicators exist. Other indicators include drops in market prices, or other indications of reductions in the present value of future cash flows from their individual cash-generating units can indicate goodwill impairment.

With information form Nathalie Boschat at the Wall Street Journal