Accounting & Tax

FASB Change May Turn Analysts’ Focus to Cable Firms’ Net

The new goodwill rules could shift analysts' attention away from EBITDA.
CFO.com StaffJuly 16, 2001

According to Dow Jones Newswires, the Financial Accounting Standards Board’s new rule eliminating goodwill amortization could change the way analysts look at cable firms’ balance sheets.

Many analysts focus on cable operators’ earnings before interest, taxes, depreciation and amortization, or EBITDA, a measure that casts favorable light on companies that are acquisitive or highly leveraged. That is because EBITDA strips out interest payments on debt as well as any decline in the value of acquired assets. EBITDA also excludes taxes and the amortization of goodwill. Up to now, companies have been required to gradually write off goodwill, which is the difference between the amount paid for an acquisition and the underlying value of its net assets.

FASB eliminated that practice. Instead, companies will be allowed to leave goodwill assets on their balance sheet, untouched, until they deem the value of those assets impaired. At that point, they must take a charge on the depressed value of those assets.

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“I get the impression that people are prepared to look at net income going forward in light of the FASB change,” Robert Willens, a tax and accounting analyst at Lehman Brothers told Dow Jones.

The change in practice will erase the difference between net income and cash earnings, a metric used by some analysts, such as John Martin of ABN Amro, to assess cable companies, says the news service. Cash earnings take into account all expenses measured by generally accepted accounting principles except the amortization of goodwill.

“In some respects, the cable industry has been self-serving in terms of focusing on Ebitda,” ABN Amro’s Martin told Dow Jones. “If you rely just on one metric called Ebitda you’re missing the boat.”

He notes that Ebitda favors companies that have spent heavily like Charter Communications Inc., Adelphia Communications Corp. and Cablevision Systems Corp., at the expense of those that have been more conservative, such as Comcast Corp., and Cox Communications Inc. Officials from the companies listed weren’t available to comment.

Among analysts covering real-estate investment trusts, the focus is shifting away from “pro forma” results that factor out unfavorable expenses, and toward net income, Dow Jones adds. Recently, Morgan Stanley, Goldman Sachs, Merrill Lynch and Salomon Smith Barney have begun forecasting REITs’ net income, as well as the pro forma metric, funds from operations. Like the cable industry, the real-estate industry requires acquisitions and heavy spending on capital expenses like construction.

However, some analysts argue that net income is an unfair measure for younger cable companies, like Charter and Adelphia, that need to spend heavily on networks before they can acquire subscribers to generate cash, says Dow Jones.

Some such analysts, such as Matt Riegner of Janco Partners, focus on free cash flow rather than EBITDA for those small cable firms. Riegner explained to Dow Jones that Wall Street can’t focus on those companies’ bottom line until they approach profits, something that seems a long way off. Free cash flow strips out interest expense, but not amortization or depreciation. Some amortization will remain under the new FASB rule. While they can no longer amortize goodwill, companies will amortize intangible assets such as licenses. Such amortiztion of intangibles is more relevant to the telecommunications industry, where new participants point to an array of measures of financial performance other than net income, says Dow Jones.

Other analysts add that when analyzing these young cable firms, the goal in focusing on cash flow is to keep in mind the stage of the companies’ development, and not portraying those companies in a good light.

But the Securities and Exchange Comission isn’t buying it.

The bottom line number is an important measure, even for young companies with heavy capital requirements, says Lynn Turner, chief accountant at the Securities and Exchange Commission. “You want to see if, over time, the trend is right for moving from a lot of losses, to fewer losses, to profit,” he told Dow Jones.