Goodwill Hunting

When boards of directors convene to review a dismal 2008, many will vote to leave shareholders with even less. They may have little choice. At dozens of public companies, market values now languish below book values, a situation that makes write-offs likely. While many CFOs may balk at such a move, regulators and stakeholders are increasingly demanding that balance sheets get a makeover. As a result, finance departments are wielding scalpels, knives, and even the occasional ax. Their specific focus: goodwill.

That was the case at Mohawk Industries, the country's second largest rug and carpet maker. "The stock-price decline below book value really drove us toward an early assessment of goodwill," says CFO Frank Boykin. Despite some misgivings about whether a stock-price drop was a sufficient cause for goodwill impairment, Boykin launched an expensive and onerous review process that involved more than two dozen managers from across the company, not to mention some high-priced external advisers.

An assistant controller managed the two-step process nearly full time for a month and a half. The first step was to calculate discounted cash flows and earnings multiples at business-unit levels, in the hopes that they would, when consolidated, nearly match the stock price. When they fell too far short, Mohawk embarked on a comprehensive step two. "You assess every asset and liability on your books and compare the sum of those fair-value calculations with the value you came up with for the total enterprise. Whatever is left is now your new goodwill," Boykin says. "That number drives the impairment charge, the difference between old goodwill and new goodwill."

Plenty of Company
In November, Mohawk announced a preliminary $1.4 billion impairment charge covering goodwill and other intangible assets. It reduced the book value of goodwill by 45 percent and equity by 27 percent. Mindful that a further drop in stock price could result in more charges down the road, Boykin's chief satisfaction lies in moving on. "I am happy that it is behind us," he says. "Our team did an excellent job in a very short time."

Write-offs surged in the throes of the 2001 recession as companies pared book value by $51 billion, or 20 times all the write-offs recorded from 1994 through 2000. The trend was partly driven by a last chance to toss out impaired assets under looser rules: in January 2002, FAS 142 and 144 kicked in, covering disposal of goodwill, intangibles, and long-lived assets that did not live as long as planned. Write-offs ticked down steadily, to less than $2.5 billion, until a fivefold increase in 2007 provided a harbinger of 2008. Today, the prospect of substantially reduced cash flow makes goodwill more vulnerable to write-offs than it has been in years.

Mohawk's symptoms surfaced in the third quarter of 2007; by early December 2008, market capital at more than one in six S&P 500 companies languished below tangible book value, including such household names as International Paper, Valero Energy, Alcoa, Office Depot, Tyson Foods, Motorola, and Goodyear.

When to Play the Card?
When companies must adjust book values downward, goodwill serves up a juicy target. Topped by General Electric with more than $81 billion, 419 S&P 500 companies posted total goodwill worth $1.8 trillion as 2008 rolled to a close. Median goodwill was $1.2 billion.

Unlike depreciable tangible and intangible assets, goodwill can reside forever on balance sheets with no amortization to cause a drag on earnings. A tough business climate with mounting impairment reminds managers that goodwill is expendable.

No wonder, then, that many companies have begun chipping away at goodwill. A $171 million write-off extinguished the remaining goodwill at Morris Publishing. Coping with less demand for its travel services, Orbitz Worldwide took a $297 million charge for impairment of goodwill and intangible assets. Griffon Corp., a diversified supplier of electronic information, specialty plastics, and garage doors, lopped off $13 million of goodwill in its garage-door business.

Goodwill write-offs have long been a card that companies can play in any number of situations, from compensating for losses to allowing a new CEO to start fresh, or fresher. But in playing the card solely as a response to declining stock prices, are companies being shrewd, or rash? "The big question is whether, and to what extent, market cap is a good proxy for underlying asset values," says corporate tax expert Robert Willens.

Accounting rules leave room for interpretation. Most finance executives flatly reject market fluctuations as sufficient cause alone to jettison assets. "Is the share price reflecting the fundamentals? The answer is no," says CFO Wayne R. Brownlee of Potash Inc., the world's leading producer of the main ingredient in fertilizer. International Paper's chief accounting officer, Fred Bleier, concurs. "It's just hard to understand that if your share price decreases 20 percent in one day that really reflects some kind of decline in your economic value," he says. "If you were in liquidation mode, it would be a valid approach. In an operating mode, where you have cycles, real fair value to an entity running its business is more related to expected cash generation than to the trading price today."

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LinkedIn Company Connections:

• Mohawk Industries |
• International Paper |
• Valero Energy |
• Alcoa |
• Office Depot |
• Tyson Foods |
• Motorola |
• Goodyear |
• General Electric |
• Morris Publishing |
• Orbitz Worldwide |
• Griffon Corp. |
• Sprint |
• Courier Corp |
• McGladrey Pullen |
• Boston Consulting Group