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October 24, 2007
Counting on intangibles -- not in DC
Yesterday, the DC City Council voted on a plan to support a local hospital in danger of closing -- see Hospital Deal Gets Financing From D.C. - washingtonpost.com. This vote came in spite of a last minute warning by the city's Chief Financial Officer. Part of the warning in the CFO's Fiscial Impact Statement is because the hospital's "liabilities exceed tangible assets by approximately $34 million." The company's financial statements carry $34 million of goodwill.
I'm not an accountant and I haven't seen the company's financial statements. Thus, I am in no position to argue one way or another on the CFO's bottom line concern that "should the business plan fail, it is likely that additional funds of substantial amounts will be needed to keep the Hospital running." I think that is probably a truism -- if any business plan fails, additional investments are probably needed to keep the operation going. The risk that city is taking is that it is potentially signing on to a long term hospital subsidy (but that is exactly the risk they may need to take to provide health care -- a question well beyond my job description).
I do find the CFO's reliance on only tangible assets of specific interest. Again, without having looked at the company's financials, I can't make a call here. Many financial sins can be hidden under the category of "goodwill" (which is exactly why FASB eliminated pooling and requires companies to break out intangibles from goodwill in acquisitions). But I have to believe that that well-run hospitals have a huge amount of intangible assets.
The Post story gets to this point:
One of [CFO Natwar] Gandhi's main points of contention involved Specialty's claim of $34 million in "goodwill" assets, which the company expected the city to accept as proof that it could cover its liabilities.
"Goodwill" is an accounting term used to characterize assets that are not tangible -- the value of a company's name or its customer base, for example. In Specialty's case, the goodwill referred to the value of its two other D.C. hospitals, which provide skilled nursing and long-term acute care. The company maintains that the facilities are worth more than the simple value of their medical equipment.
But Gandhi decided that goodwill represents "intangible assets" that should not count toward Specialty's ability to meet its liabilities, government sources said.
[Company representative George] Lowe disputed Gandhi's analysis. He said Specialty had $84 million in gross receipts and turned a profit of $14 million this past year. He noted that its hospital in Southeast sits on 66 acres appraised at $35 million, and its Capitol Hill facility is worth $15 million for its business operations alone.
"The company is not insolvent," Lowe said. "The company is performing very well."
Audited financial statements back up its claims, he said.
(Apparently those audited financial statements were never made available to the city's CFO).
Earlier this year, I posted an item on the new rules for account of state and local intangible assets.. Again, without having seen the company's financial statements, and not being an accountant, I can't say whether applying these rules would result in a different outcome by the CFO.
The other part of this transaction that concerns me is whether the intangible assets were included in the deal. Not having seen the details of the deal, I can’t speak to whether any of the company's intangible assets might be used as collateral to backstop the city's investment. But if the company is going to claim intangible assets as a major part of their asset base, the city should have a claim on those assets if the deal goes south. It appears from the CFO's analysis that the only backstop for the city (outside of being a standard unsecured creditor) is part of the real estate.
Given that hospitals are a prime example of a knowledge-based, intangible-heavy institution, there was a missed opportunity here. Completely excluding intangible assets results in an incomplete picture of the company (and the investment proposals) and in a failure to capitalize on those intangibles as part of the deal. The fiscal impact statement should have included an analysis of the intangible assets and the deal should have been structured to incorporate those intangibles into the financial arrangements.
Posted by Ken Jarboe at October 24, 2007 9:31 AM
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