Goodwill Hunting - CFO
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Print this article | Return to Article | Return to CFO.com Goodwill Hunting For companies mulling writeoffs, economic turmoil is a terrible thing to waste. S.L. Mintz , CFO Magazine January 1, 2009 When boards of directors convene to review a dismal 2008, many will vote to leave shareholders with even less. They may have little choice. At dozens of public companies, market values now languish below book values, a situation that makes writeoffs likely. While many CFOs may balk at such a move, regulators and stakeholders are increasingly demanding that balance sheets get a makeover. As a result, finance departments are wielding scalpels, knives, and even the occasional ax. Their specific focus: goodwill. That was the case at Mohawk Industries, the country's second largest rug and carpet maker. "The stockprice decline below book value really drove us toward an early assessment of goodwill," says CFO Frank Boykin. Despite some misgivings about whether a stockprice drop was a sufficient cause for goodwill impairment, Boykin launched an expensive and onerous review process that involved more than two dozen managers from across the company, not to mention some highpriced external advisers. An assistant controller managed the twostep process nearly full time for a month and a half. The first step was to calculate discounted cash flows and earnings multiples at businessunit levels, in the hopes that they would, when consolidated, nearly match the stock price. When they fell too far short, Mohawk embarked on a comprehensive step two. "You assess every asset and liability on your books and compare the sum of those fairvalue calculations with the value you came up with for the total enterprise. Whatever is left is now your new goodwill," Boykin says. "That number drives the impairment charge, the difference between old goodwill and new goodwill." Plenty of Company In November, Mohawk announced a preliminary $1.4 billion impairment charge covering goodwill and other intangible assets. It reduced the book value of goodwill by 45 percent and equity by 27 percent. Mindful that a further drop in stock price could result in more charges down the road, Boykin's chief satisfaction lies in moving on. "I am happy that it is behind us," he says. "Our team did an excellent job in a very short time." Writeoffs surged in the throes of the 2001 recession as companies pared book value by $51 billion, or 20 times all the writeoffs recorded from 1994 through 2000. The trend was partly driven by a last chance to toss out impaired assets under looser rules: in January 2002, FAS 142 and 144 kicked in, covering disposal of goodwill, intangibles, and longlived assets that did not live as long as planned. Writeoffs ticked down steadily, to less than $2.5 billion, until a fivefold increase in 2007 provided a harbinger of 2008. Today, the prospect of substantially reduced cash flow makes goodwill more vulnerable to writeoffs than it has been in years. Mohawk's symptoms surfaced in the third quarter of 2007; by early December 2008, market capital at more than one in six S&P 500 companies languished below tangible book value, including such household names as International Paper, Valero Energy, Alcoa, Office Depot, Tyson Foods, Motorola, and Goodyear. When to Play the Card? When companies must adjust book values downward, goodwill serves up a juicy target. Topped by General Electric with more than $81 billion, 419 S&P 500 companies posted total goodwill worth $1.8 trillion as 2008 rolled to a close. Median goodwill was $1.2 billion. Unlike depreciable tangible and intangible assets, goodwill can reside forever on balance sheets with no amortization to cause a drag on earnings. A tough business climate with mounting impairment reminds managers that goodwill is expendable. No wonder, then, that many companies have begun chipping away at goodwill. A $171 million writeoff extinguished the remaining goodwill at Morris Publishing. Coping with less demand for its travel services, Orbitz Worldwide took a $297 million charge for impairment of goodwill and intangible assets. Griffon Corp., a diversified supplier of electronic information, specialty plastics, and garage doors, lopped off $13 million of goodwill in its garagedoor business. Goodwill writeoffs have long been a card that companies can play in any number of situations, from compensating for losses to allowing a new CEO to start fresh, or fresher. But in playing the card solely as a response to declining
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Transcript of Goodwill Hunting - CFO
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GoodwillHuntingForcompaniesmullingwriteoffs,economicturmoilisaterriblethingtowaste.S.L.Mintz,CFOMagazineJanuary1,2009
Whenboardsofdirectorsconvenetoreviewadismal2008,manywillvotetoleaveshareholderswithevenless.Theymayhavelittlechoice.Atdozensofpubliccompanies,marketvaluesnowlanguishbelowbookvalues,asituationthatmakeswriteoffslikely.WhilemanyCFOsmaybalkatsuchamove,regulatorsandstakeholdersareincreasinglydemandingthatbalancesheetsgetamakeover.Asaresult,financedepartmentsarewieldingscalpels,knives,andeventheoccasionalax.Theirspecificfocus:goodwill.
ThatwasthecaseatMohawkIndustries,thecountry'ssecondlargestrugandcarpetmaker."Thestockpricedeclinebelowbookvaluereallydroveustowardanearlyassessmentofgoodwill,"saysCFOFrankBoykin.Despitesomemisgivingsaboutwhetherastockpricedropwasasufficientcauseforgoodwillimpairment,Boykinlaunchedanexpensiveandonerousreviewprocessthatinvolvedmorethantwodozenmanagersfromacrossthecompany,nottomentionsomehighpricedexternaladvisers.
Anassistantcontrollermanagedthetwostepprocessnearlyfulltimeforamonthandahalf.Thefirststepwastocalculatediscountedcashflowsandearningsmultiplesatbusinessunitlevels,inthehopesthattheywould,whenconsolidated,nearlymatchthestockprice.Whentheyfelltoofarshort,Mohawkembarkedonacomprehensivesteptwo."Youassesseveryassetandliabilityonyourbooksandcomparethesumofthosefairvaluecalculationswiththevalueyoucameupwithforthetotalenterprise.Whateverisleftisnowyournewgoodwill,"Boykinsays."Thatnumberdrivestheimpairmentcharge,thedifferencebetweenoldgoodwillandnewgoodwill."
PlentyofCompanyInNovember,Mohawkannouncedapreliminary$1.4billionimpairmentchargecoveringgoodwillandotherintangibleassets.Itreducedthebookvalueofgoodwillby45percentandequityby27percent.Mindfulthatafurtherdropinstockpricecouldresultinmorechargesdowntheroad,Boykin'schiefsatisfactionliesinmovingon."Iamhappythatitisbehindus,"hesays."Ourteamdidanexcellentjobinaveryshorttime."
Writeoffssurgedinthethroesofthe2001recessionascompaniesparedbookvalueby$51billion,or20timesallthewriteoffsrecordedfrom1994through2000.Thetrendwaspartlydrivenbyalastchancetotossoutimpairedassetsunderlooserrules:inJanuary2002,FAS142and144kickedin,coveringdisposalofgoodwill,intangibles,andlonglivedassetsthatdidnotliveaslongasplanned.Writeoffstickeddownsteadily,tolessthan$2.5billion,untilafivefoldincreasein2007providedaharbingerof2008.Today,theprospectofsubstantiallyreducedcashflowmakesgoodwillmorevulnerabletowriteoffsthanithasbeeninyears.
Mohawk'ssymptomssurfacedinthethirdquarterof2007byearlyDecember2008,marketcapitalatmorethanoneinsixS&P500companieslanguishedbelowtangiblebookvalue,includingsuchhouseholdnamesasInternationalPaper,ValeroEnergy,Alcoa,OfficeDepot,TysonFoods,Motorola,andGoodyear.
WhentoPlaytheCard?Whencompaniesmustadjustbookvaluesdownward,goodwillservesupajuicytarget.ToppedbyGeneralElectricwithmorethan$81billion,419S&P500companiespostedtotalgoodwillworth$1.8trillionas2008rolledtoaclose.Mediangoodwillwas$1.2billion.
Unlikedepreciabletangibleandintangibleassets,goodwillcanresideforeveronbalancesheetswithnoamortizationtocauseadragonearnings.Atoughbusinessclimatewithmountingimpairmentremindsmanagersthatgoodwillisexpendable.
Nowonder,then,thatmanycompanieshavebegunchippingawayatgoodwill.A$171millionwriteoffextinguishedtheremaininggoodwillatMorrisPublishing.Copingwithlessdemandforitstravelservices,OrbitzWorldwidetooka$297millionchargeforimpairmentofgoodwillandintangibleassets.GriffonCorp.,adiversifiedsupplierofelectronicinformation,specialtyplastics,andgaragedoors,loppedoff$13millionofgoodwillinitsgaragedoorbusiness.
Goodwillwriteoffshavelongbeenacardthatcompaniescanplayinanynumberofsituations,fromcompensatingforlossestoallowinganewCEOtostartfresh,orfresher.Butinplayingthecardsolelyasaresponsetodeclining
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stockprices,arecompaniesbeingshrewd,orrash?"Thebigquestioniswhether,andtowhatextent,marketcapisagoodproxyforunderlyingassetvalues,"sayscorporatetaxexpertRobertWillens.
Accountingrulesleaveroomforinterpretation.Mostfinanceexecutivesflatlyrejectmarketfluctuationsassufficientcausealonetojettisonassets."Isthesharepricereflectingthefundamentals?Theanswerisno,"saysCFOWayneR.BrownleeofPotashInc.,theworld'sleadingproducerofthemainingredientinfertilizer.InternationalPaper'schiefaccountingofficer,FredBleier,concurs."It'sjusthardtounderstandthatifyoursharepricedecreases20percentinonedaythatreallyreflectssomekindofdeclineinyoureconomicvalue,"hesays."Ifyouwereinliquidationmode,itwouldbeavalidapproach.Inanoperatingmode,whereyouhavecycles,realfairvaluetoanentityrunningitsbusinessismorerelatedtoexpectedcashgenerationthantothetradingpricetoday."
ButWallStreettendstotaketheviewthatmarketvalueandfairvaluearesynonymous."Mostanalystsassumethattheyareequivalent,"saysWillens,"withtheresultthatmarketdeclineswe'veexperiencedshouldpresagegoodwillimpairmentandleadtomassivegoodwillwritedowns."AndBleieragreesthataplungingsharepriceInternationalPaperfellfrom$30ashareinSeptemberto$11inearlyDecemberdoesindicateapotentialforimpairment.
Farfrompreservingvalue,saysRayBall,afinanceprofessorattheUniversityofChicago'sBoothGraduateSchoolofBusiness,suppressingwriteoffscanforestallrecovery.Japaneseregulatorslearnedthatlessonwhentheireconomycollapsedintorecessionnearlytwodecadesago.ByallowingJapanesecompaniestoretaininvestmentsontheirbooksatcostevenafterthecountry'sstockmarketcratered,saysBall,regulatorsdrainedawayanyincentivetoaddressovervaluedassets."WriteoffsforceCFOstoidentifytheirvaluableassets,"Ballinsists."Decisionsthatmakebooksmoreconsistentwitheconomicrealityacceleraterecovery."
Academicsacrossthecountrytendtoagree."Therecenttroublewillresultinalotoffirmsreducinggoodwill,"saysSouthernMethodistUniversityprofessorDougHanna,whohasstudiedsocalledbigbathwriteoffsoverthreedecades."Wehaveaperiodnowwhentheentiremarketisexpectingfirmstoreport[poor]results,"hesays."Itopensdoorstogetridofalotofbadthingsatonce."
Opportunityisknockingloudlynow,saysKristiMinnick,anassistantprofessoratBentleyCollege.Minnickputhistoricalwriteoffsunderamicroscopeinher2005Ph.D.thesis,"WriteoffsandCorporateGovernance."Whenstocksgivebackahalfdecadeofgains,shesays,writeoffsgoalmostunnoticed."Marketswouldnotbepunitiveinanyway,shape,orform,"Minnickinsists.Thechancetounloadimpairedassetswithoutrattlingthestockmarketresemblesbulkwastedayinthesuburbs,wheneverythingunwantedgetscartedaway,noquestionsasked.
Duringthefirsthalfof2008,goodwillwriteoffsaveraged$652million,accordingtodatagatheredbyLosAngelesbasedinvestmentbankHoulihanLokey.Themediandisposalchargewas$211million.A$6.1billionwriteoffbyDeltaAirLineserasedalmosthalfofitsgoodwillbalance,afairlytypicalratio.Averageandmediangoodwillimpairmentsaspercentagesofgoodwillbalances,accordingtoHoulihanLokey,were48.5percentand46.5percent,respectively.
LimpingAwayWhencompaniesrecordgoodwillimpairment,cashhaslongsinceleftthebuilding.Chargesarenoncashbydefinition,vestigesoftransactionspastandnotjusttargets'excessivepricetags.Payingwithoverpricedsharesmayleadtomostgoodwillwriteoffs,accordingtoastudybyFengGuoftheStateUniversityofNewYork(Buffalo)andBaruchLevofNewYorkUniversity'sSternSchoolofBusiness.Theydeterminedthat"overpricedsharesprovidebuyersandmanagementofthebuyerswithstrongincentivestoacquirebusinesses,evenatexcessivepricesanddoubtfulstrategicfit,inordertobuythemselvesoutoftheoverpricedsharepredicamentandpostponetheinevitablepricecorrectionbyportrayingcontinuedgrowth."
Becausegoodwillwriteoffsimposenocashimpact,companiescanlimpawayfrommassiveevents,asSprintdidlastMarchafterbiddinggoodbyeto$30billionofgoodwill,whichstemmedlargelyfromits2005acquisitionofNextel,orasTimeWarnerdidin2002followingitsdisastrousAOLmerger.Sprint'swriteoffripped$29billionfromshareholders'equity.
Companiestypicallyrefrainfromwriteoffsfortworeasons:stockholdersandlenders.InapostSarboxworld,saysoneattorney,companiesthatmayoncehaveresistedwriteoffsforfearthattheygiveoffadistinctwhiffoffailuremayhavelittlechoicebuttomoveaheadifimpairmentshavebecomevisible.Anylegalbasisfornotdisclosinghasgoneaway.Timelydisclosurenowispartofthejob,andanobligation."SinceSarbox,companiescannotdisclosefastenough,"theattorneysays."Nobodywantstogotojail."
WhilenoCFOwantstogotoprison,somemaystillbetemptedtomanagemarketreaction,andonsomelevelyoucan'tblamethem.Aftera$24milliongoodwillwriteoffearlyin2008(athirdofitsgoodwillbalance),CourierCorp.
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suffereda21percentslumpinitsstockprice.Butthesedaysthatkindofmarketreactionmaybetheexception,becauseinvestors,saysBentley'sMinnick,candifferentiatebetweenwriteoffsthatwillimproveperformanceandwriteoffsthatwon't.
IntheHoulihanLokeystudy,averagegoodwillwriteoffsinthefirsthalfof2008reducedstockpriceby4percentonthefirstfulltradingday.Onethirdofthesamplesawarelativestockpricechangeoflessthan2.5percent.Meanwhile,10companiesenjoyedanaverage4.5percentbumpintheirstockprices,withHarrisInteractiverealizinga10.5percentincrease.
Onekeytominimizingthedamageistocommunicateregularlywithinvestors."Youwillnotseematerialreactioninthestockpriceifmanagementhasbeendisclosingrealignment,"saysLarryLevine,directorofcorporatefinanceandbusinessvaluationservicesatMcGladreyPullen."Inanefficientmarketyouwouldnotexpectthepricetomove,ormovementwouldbedeminimisatmost."
Infact,writeoffscanbeperceivedasaformofgoodnews,saysmanagementconsultantEricOlsenofBostonConsultingGroup.Theymayejectobsoleteinventory,badreceivables,orotherbaggagethatinvestorsknowaboutandthemarketpricereflects."Takethatwriteoff,"saysOlsen."It'sgoodnewsbecauseyouarenotsurprisingtheStreet.You'resayingtoshareholders,'We'rewithyouwe'lladdressthisissuenow.'"Conversely,Olsensays,writeoffscanalsobeperceivedastotallyunexpectedbadnews,aswhentheyrevealthatworkingcapitalisnotundercontrol.
Whileshareholdersmayreactfavorablybasedontheirperceptionoffutureprosperity,lendersreacttowriteoffsinadifferentway.Theywieldlegalcontractsthatimposepenaltiesifgoodwillwriteoffsviolateassetbasedcovenants."Whenareallossiswrittenonthebalancesheet,"saystheUniversityofChicago'sBall,"lenderscanenforcetheircontractualrights."Writeoffsalertlendersthatloansareskatingonthinnericeandmayriskatechnicaldefaultoraharshchangeinterms.
Mohawk'srecentwriteoffshranktotal2007assetsby16percent,butCFOBoykinknewhiscreditlinewassafe."Ourdebttocapitalizationratiostaysbelow60percent,"saysBoykin."Evenwiththewriteoffwehadplentyofroom.Butyoumusttakealookatthatearlyintheprocess."
Likethemornot,asaresponsetoabesiegedstockprice,goodwillwriteoffspromotepenanceandrenewal.Theyownuptopastmistakes,repairbalancesheets,andhelprestoreinvestorconfidence.Ascorporatedecisionsgo,toerrishuman,totakeagoodwillwriteoffissublime.
S.L.MintzisadeputyeditorofCFO.
WhenWriteOffsGoWrong
Whilegoodwillwriteoffshavemanyvirtues,don'tassumetheywillgeneratetaxbenefits.Sprintreportedthatthe"substantialmajority"ofitsgiantwriteoffproducednotaxbenefitatall.
Benefitsaccrueonlywhenatransactionthatproducedgoodwillwassetupinitiallyasataxablepurchaseofthetarget'sassets,arareoccurrence.Undertakenwithunbridledoptimism,likemostmergers,Sprint'smergerwithNextelwasneverstructuredtoproducetaxbenefitsifitfailed."Thegoodwillimpairmentcharge,"sayscorporatetaxexpertRobertWillens,"hadtheeffectofpenalizingSprint'snetincomeandshareholders'equitywithoutanaccompanyingtaxbenefit:theworstofallworlds."
Evenwhenrecordingimpairmentoftangibleorintangibleassets,writeoffscanbetricky."Thereisnoautomaticdeduction,"warnscorporatetaxaccountantPaulBeecyatGrantThornton.Deductionsordinarilyoccurwhenanassetbecomesworthlessandmeansabsolutelyzero.Inthatcase,Beecyadvises,getridofittoforestallanydoubtaboutyourconviction.Theremaybesomeopportunitiesforpartialworthlessness,buttheydon'tapplyjustbecauseaviablecustomerisshortofcashanddoesnotwanttopay."Unlessyoudisposeoftheasset,"saysBeecy,"youarefacinganuphillbattle."S.L.M.
ViewtheS&P500deficitschart.
CFOPublishingCorporation2009.Allrightsreserved.
