Investors Can See Clearly Now

Analysts at Houlihan Lokey Howard & Zukin, an investment bank, followed 19 companies across industries that wrote off goodwill through July of this year, including JDS Uniphase, Nortel, Ariba, Aetna, and VeriSign. Companies that took impairment charges below 100 percent of their market capitalization saw share prices decrease an average of 1 percent. When the goodwill charge was above 100 percent of market capitalization, share prices dropped an average of 5 percent. JDS Uniphase, for example, took a $45 billion impairment charge in July, which amounted to 398 percent of the company's total market cap. The day after the write-down was publicly announced, the company's share price dropped almost 10 percent.

Although direct causality is hard to nail down, these findings may at least point to a correlation between big goodwill write-downs and drops in share prices. What's more, large write-downs may not to be limited to the telecommunications and technology sectors, notes Karen Miles, senior vice president at Houlihan Lokey. "Companies across sectors that have had significant price drops, and made lots of acquisitions when prices were high, are the ones that are going to get hit," she notes.

The Short Run
In the more immediate future, analysts contend, there is potential for confusion — and some ups and downs in share prices. As companies begin adopting the rules under different timetables, investors may find it hard to track the changes and make consistent comparisons. Patricia McConnell, an accounting analyst at Bear Stearns, believes that it could take up to 21 months before all companies are reporting on the same basis. Uncertainty could breed volatility.

Share prices may also fluctuate as investors react to the initial boost in earnings that many companies will experience, as goodwill amortization no longer erodes the bottom line. In theory a change in accounting for goodwill and intangibles should have no effect on a company's shares, since it has no impact on cash flow. But some of the changes may have more of an effect on share prices than most people anticipate.

"We think there is going to be some stickiness in P/E multiples, since many investors only look at pricing in terms of P/E ratios for many industries and companies," Miles notes. P/E multiples would have to adjust significantly for many companies if their market capitalization were to remain unchanged, she adds.

In a Bear, Stearns report, "The End of Pooling & Goodwill Amortization Is Near," published in February, analysts maintain that companies that have traditionally been valued on a P/E basis are likely to experience the most significant fluctuations. Those that are valued on an EBITDA or cash-flow basis are least likely to see a change.

In the end, investors will need to weigh the importance of the noncash charges companies take when goodwill becomes impaired. In some cases, they will decide that there's been no deterioration in a company's underlying value. In others, investors may conclude that the impairment of goodwill may, indeed affect operational performance. Ultimately, they will probably have to make that calculation on a case- by-case basis.

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