Fourth-quarter earnings are rolling in, and so is a new set of hefty write-offs that reflect the tumbling value of bubble-era acquisitions.
The write-offs aren't just coming from financial corporations recalculating the worth of their toxic loans. Many of the biggest charge-offs of late have come from companies far from the Wall Street fray, such as Jones Apparel (JNY), News Corp. (NWS), Boston Scientific (BSX), and Ingersoll-Rand (IR). These companies are writing off billions of dollars in goodwill, as they reevaluate the worth of assets they once paid big bucks to acquire.
Experts predict still more write-offs are on the way. In a January report, Goldman Sachs (GS) strategists Abby Joseph Cohen and Michael Moran issued a report noting that the balance sheets of the Standard & Poor's 500 companies contain more than $2.6 trillion of goodwill and intangible assets. That's more than half of the companies' combined book value. Think of it as the leftovers of the M&A binge of the last 10 years.
Now, a good chunk of that will probably have to go.
When Goodwill Goes Bad
Goodwill is an accounting term that describes the difference between the price one company pays for another and the tangible assets of the company that's being bought. If the buyer pays more than the book value of the acquisition's assets, it's called goodwill and put on the acquiring company's books as an asset. Periodically, though, the acquiring company has to review that goodwill to see if it's in good shape.
In many cases these days, it isn't. Women's clothing maker Jones Apparel spent much of the past decade vacuuming up other companies in a bid to broaden its offerings and obtain more leverage with retailers. Peter Boneparth, a former investment banker who was Jones' CEO from 2002 to 2007, bought up jeans companies, suit makers, even the clothing lines of Gloria Vanderbilt. One of his most contentious deals was a hostile 2004 bid for Maxwell Shoe Co. He eventually paid $346 million for it, adding to Jones' Nine West brand, which the company had bought in 1999 for $885 million, plus $500 million in assumed debt.
On Feb. 11, however, the company made a sobering reassessment of that strategy, writing down $838 million of goodwill, mostly from its footwear deals. That adjustment more than erased the company's entire 2008 profit.
If these write-offs are seen as a report card on deals done, a lot of major companies are getting "F"s: Sprint-Nextel (S) has taken a $30 billion write-off, virtually the entire value of its 2005 and 2006 purchases of two Nextel businesses, after a sharp drop in wireless subscriptions. Alcatel-Lucent (ALUA), which was formed after the 2006 $11.4 billion acquisition of Lucent, wrote off $5 billion from that deal. Just in the past few days, News Corp. has lopped off $8.4 billion of goodwill, and Time Warner (TWX) $24 billion. Boston Scientific's acquisition of heart-implant maker Guidant hasn't paid off as expected; that led to a $2.7 billion write-off and contributed to a $2.4 billion net loss for the company in the last quarter of 2008.
Implications of a Write-off
These write-offs are counted against net income, earnings per share, and book value, but they don't cost the company any cash. So investors sometimes dismiss them as one-time issues. But David Zion, accounting analyst at , says the write-offs make an important statement about the prospects of the companies taking them. The way companies calculate values is by evaluating the business itself; if they're taking far larger write-offs than investors had expected, business prospects may be weakening.
"What's the company telling you?" Zion says investors should ask themselves. He also notes that declining book value can affect a company's debt covenants.
Furthermore, the parade of goodwill write-downs may be only the beginning of a long-term trend. Between 1999 and 2008, $25.8 trillion in deals were consummated, according to ThomsonReuters. Some $7 trillion of that was done in 2007 and 2008, before the financial markets began their full meltdown.
So who's next? Zion has put a list together of the companies with the biggest gap between the goodwill on their balance sheets and the market's apparent valuation of that goodwill based on the stock price at the end of 2008. Many companies on the list have taken big write-downs since he put the list together, including supermarket chain Supervalu (SVU), oil and gas giant ConocoPhillips (COP), and metals company Freeport-McMoran (FCX).
But others on the list—including Tyco Electronics (TEL) and Carnival (CCL), parent of Carnival Cruise Lines—have not taken write-downs so far, despite billions in goodwill that investors seem to be giving no value. Two of them—Expedia (EXPE), the online travel outfit, and giant retailer Macy's (M)—are scheduled to release results in the next few weeks.
Byrnes is a senior writer for BusinessWeek in New York.