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The big question for many investors is whether the backlash from past mergers will cool deal valuations going forward.
Alix Stuart, CFO.com | US
July 1, 2009
The hits just kept coming last winter, as company after company reported huge goodwill impairment charges along with their 2008 earnings. Among the biggies: Conoco Phillips's $25 billion writedown and CBS Corp's $14 billion one, plus multi-billion impairment charges from Citigroup, Regions Financial, and AIG.
A billion here and a billion there, and it starts to look like real money. A new report by KPMG, in fact, tallies by just how much: a grand total of $340 billion for over 1600 large companies, or about one-third of all the goodwill recorded on their books, according to Seth Palatnik, partner in KPMG's Valuation Services practice. "This was a big deal for many public companies," he says. Nearly 300 companies in the study took such charges in reporting 2008 earnings, up from less than 100 the year before. All told, over 400 public companies recorded goodwill impairment charges in the past 12 months, according to data retrieved from Capital IQ for CFO.com.
The big question for many investors is whether this backlash from past mergers will affect deal valuations going forward. Not likely, say some executives. Audiovox , which owns RCA and Energizer brands, among others, recorded a $39 million charge related to goodwill last year. But those charges are unlikely to affect the company's appetite for acquisitions going forward, CEO Patrick Lavelle said in a May earnings call. Decisions about making a deal rely on "the sales that we're picking up and the gross profit and the income that's generated from that gross profit, along with our ability to leverage our existing overhead so that we can reduce the overhead of the acquired company," he said. "The goodwill doesn't really, in my estimation, enter into that decision."
Goodwill, or the value of an acquisition's intangible assets over and above its purchase price, must be tested at least yearly, according to FAS 142, and more often when a "triggering event" occurs. For the most part, it was the "triggering event" of dragging stock prices that made book values look too high, forcing the goodwill testing and subsequent write-downs, says Palatnik. While the charges don't affect cash flow, they take a slice out of shareholders' equity and earnings-per-share estimates, and imply that a company overpaid for the acquisitions it's now writing down. Depending on how a company's loans are structured, the sudden asset shrinkage could also trigger covenant violations.
Goodwill-related charges more than doubled from 2007, when $143 billion of goodwill was written down, and more than tripled from the $87 billion of charges taken in 2006, according to the KPMG report. It's no surprise that banks were the hardest-hit sector, accounting for almost a quarter of the $340 billion. But many companies in the semiconductor, technology hardware, media, and consumer goods industries were sorely affected, too. Fourteen companies, including Symantec, Sirius XM, and Cadence Design Systems, saw impairment charges swamp annual revenue, according to data retrieved from Capital IQ for CFO.com.
Even companies in relatively healthy industries like pharmaceuticals, utilities and food and beverage saw the value of their goodwill deteriorate. "When we first started the study in 2008, goodwill impairments were much more concentrated within just a couple of industries," says Palatnik. "By the end of the year, it affected virtually every industry." Supermarket giant Supervalu, for example, wrote down almost $3.5 billion for 2008, after taking no such charges in the previous three years.
One of the risks inherent in such writedowns is the problems they can create for loan covenants that are based on minimum net worth or net asset value. As CFO.com reported in February, Expedia amended its credit facility to avoid violating a debt covenant based on net worth when it recorded a $2.76 billion goodwill impairment charge for 2008. The terms of the revised facility no longer contain net worth requirements. In June, Casella Waste Systems announced that it had negotiated a special waiver with its credit facility lenders to avoid penalties on any covenant violations that arose from goodwill write-downs, and expects to eliminate such covenants as it refinances that facility.