Risk Management

Purchase Price Allocation to Goodwill Drops

Acquirers in 2012 allocated a smaller percentage of their purchase prices to goodwill. But goodwill dwarfed any other kind of intangible.
Vincent RyanSeptember 13, 2013

How much of the purchase price of a transaction acquirers allocate to goodwill and intangible assets is more than just an academic question. Before or soon after a deal is completed, it’s key that CFOs know how the amortization of intangible assets will play out in future earnings periods and whether yearly impairment tests will cause goodwill to be marked up or down.

But often, CFOs consider the purchase price allocation report just another box to be checked on the compliance list. And “often the impact of intangible asset amortization is understated and even overlooked in the internal modeling by corporate-development teams,” says Sam Clark, managing director and head of transaction-advisory services at Houlihan Lokey.

In early September, Houlihan Lokey released its twelfth annual benchmarking report on purchase price allocation, which looked at 511 transactions in which the acquiring company was based in the United States and publicly held. The study uses purchase consideration — the sum of the purchase price paid and liabilities assumed in connection with a business combination.

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The report found that intangible assets and goodwill — the purchase consideration that is above the value of the current and tangible assets of the target company — did make up a large chunk of the price acquirers paid last year.

Excluding financial-institution transactions, which have uniquely large allocations to intangible assets, the percentage of the purchase consideration allocated to intangible assets increased to 32 percent on average in 2012, up from 26 percent in 2011. The percentage of purchase consideration allocated to goodwill, on the other hand, dropped to 31 percent on average in 2012, compared with 38 percent in 2011.

Clark says the numbers continue a trend of an increased effort to allocate more value to identified intangible assets and less to unidentified goodwill — which is subject to an annual test for impairment or when events or circumstances indicate the goodwill number does not accurately reflect value.

The intangible-assets acquirers most frequently identified were customer-related intangible assets (53 percent of deals), trademarks and trade names (41 percent), developed technology (39) and in-process research and development (9 percent). Other intangible assets typically included, among others, were non-compete agreements, licenses, permits and other contracts or agreements, according to Houlihan Lokey.

Two M&A deals in particular had a large portion of the purchase consideration classified as intangible assets: Express Scripts’ acquisition of Medco Health Solutions ($16.2 billion of intangibles, out of a total consideration of $48.6 billion), and Johnson & Johnson’s purchase of Synthes ($13 billion out of $24.2 billion).

No single category of intangible asset had a notable increase in purchase-consideration allocation. But there was a 3 percent increase in acquirers identifying “indefinite lived trade names” on the balance sheet. Those trade names are classified as indefinite because there is no limit on the time period over which they contribute to cash flows. “Auditors had a big push a few years ago to increase the scrutiny behind indefinite lives for trade names,” Clark says, which may have led to the drop that occurred in 2011. “Indefinite lived trade names have not seemed to be a focus [for auditors] lately.”

But the percent of purchase-price allocation to any one class of intangible assets is still dwarfed by the value that is being accounted for as goodwill. Ninety-five percent of the deals in Houlihan Lokey’s sample allocated some of what they paid to goodwill (three of them recorded negative goodwill). In addition, in 52 percent of the deals the amount of purchase consideration allocated to goodwill was 35 percent or higher.

Industries that had the highest median purchase price allocation to goodwill in 2012 were media, sports and entertainment; technology; and aerospace, defense and government. The industries in which deals allocated the smallest percentage of purchase consideration to goodwill were infrastructure services and metals; telecom; and energy.

The Houlihan Lokey study is mainly used to judge what precedents are being set by acquirers and what has been accepted by the public auditing firms in the accounting of acquisitions. Clark says, however,  that looking at what other acquirers in an industry are doing “gives CFOs the ability to consider their pro forma balance sheet and income statement in an acquisition setting,” which can help the finance team “refine company models for earnings per share and other pro forma guidance that they may give to shareholders or the capital markets at the announcement of an acquisition.”