Writing off "goodwill"

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For many banks, now comes the time of separating the wheat from the chaff -- in this case valuable intangibles from the froth of "goodwill" created by overpaying for assets. According to today's New York Times:

Companies are taking billions of dollars in losses as they write down the value of assets known as good will -- the amount they overpaid for a business compared with the sum of its parts. As the economy sinks lower and businesses struggle, that good will is going bad.
. . .
Banks wrote down more than $25 billion in good will in 2008, up sharply from $790 million a year earlier, according to data compiled by Frank Schiraldi of Sandler O'Neill & Partners. By the end of the year, banks still had $291 billion worth of good will on their books. An incomplete tally of write-downs from the first quarter showed that banks had taken a $3.5 billion hit to good-will values.

A bit of explanation first. In accounting terms, "goodwill" was an amorphous category where you threw all sorts of assets you couldn't figure out. When a company buys another firm, everything in the purchase price above and beyond the "fair value" is categorized as "goodwill". In 2001, the Financial Accounting Standards Board (FASB) issued Statements of Financial Accounting Standards (SFAS) 141 and 142. These required companies to separate out a long list of intangibles assets from "goodwill" and treat them differently. Goodwill therefore includes all of the speculative overpricing of the purchase as well as unidentifiable intangibles.

The definition of "goodwill" is important when reading the Times story. The story states that the goodwill includes "brand name, its customer base and reputation." Not necessarily -- since those were supposed to be pulled out from goodwill under 141/142. The story thus combines two issues: the write down on intangible assets and the write down on the goodwill.

For example, it its 10K filing with the SEC, SunTrust (mentioned in the article) had $7 billion in goodwill and slightly over $1 billion in other intangible assets. Those other intangible assets included "customer relationship." In its 1st Quarter statement, SunTrust took a $715 million write down of its goodwill -- but not of its intangible assets.

In 2008, Macy's took a $5.4 billion goodwill write down (according to its 10 K filing). But it only wrote down about $112 million in intangibles.

So, it is clear that the massive write downs are not due to intangibles loosing value. The write down are companies finally recognizing that they overpaid for previous acquisitions. As an August, 2008 paper by Feng Gu and Baruch Lev (Overpriced Shares, Ill-Advised Acquisitions, and Goodwill Impairment) hypothesize:

the root cause of many goodwill write-offs - managers' public admission of ill-advised corporate acquisitions - is the overpriced shares of buyers at acquisition. Overpriced shares provide managers with strong incentives to invest, and particularly to acquire businesses, even at excessive prices and doubtful strategic fit, in order to buy themselves out of the overpriced share predicament and postpone the inevitable price correction by portraying continued growth.
That inevitable prices correction has come about, and the effects of overpriced purchases is becoming clear.

So don't blame intangibles. The problem is bad management -- which, on second thought is an important negative intangible. But one that never shows up on the books.

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This page contains a single entry by Ken Jarboe published on April 27, 2009 10:29 AM.

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