PCCW faces multi-billion dollar accounting question
>>This article is pre-PCCW reporting of 3/28, but contains good pro's and con's on the "negative equity" results. <<
Monday, March 19, 2001
2:12 pm (GMT+8)
Pacific Century Cyberworks, headed by 34-year-old tycoon Richard Li, must resolve a massive goodwill it took when the company paid a huge premium in 2000 for Cable & Wireless HKT in a $28.5 billion deal. REUTERS/Bobby Yip
Pacific Century CyberWorks must resolve a potentially HK$190 billion (US$24.4 billion) question next week when it reports combined results for the first time since absorbing Hong Kong's dominant telco.
At issue is how the Internet and telecoms firm headed by 34-year-old tycoon Richard Li will account for the massive goodwill it took on when the company paid a huge premium last year for the much-larger Cable & Wireless HKT in a US$28.5 billion deal that was Asia's largest-ever corporate takeover.
"Does it get amortised over a period of time, or does it get written off altogether in one go? That is the question," said an analyst who declined to be named. "Probably, the investment community would like to see it just getting wiped clean."
Goodwill is used to account for the difference between the purchase price of a company and what the acquired company was actually worth on a book value (assets minus liabilities) basis.
If, as many watchers expect, PCCW writes off the entire goodwill amount in one massive charge when it releases 2000 results on March 28, it could mean the company is in a position of negative shareholder equity.
On the other hand, PCCW could choose to amortise the goodwill against its profit-and-loss statement over a period of time -- say 20 years -- which would serve as a drag on earnings going forward.
ASSET REVALUATION
Among the questions the company must answer: Should it try to mitigate the huge goodwill amount? If so, how and by what amount?
PCCW could try to decrease its goodwill by revaluing the assets it acquired. For example, network equipment -- such as a telephone line that had been fully amortised on HKT's books -- could be found to have many more years of useful life, and thus be revalued for accounting purposes, one analyst suggested.
The company declined comment, and according to analysts has provided no guidance as to how it will address the complex issue.
Another analyst who also declined to be named figures the goodwill amount will total HK$180 billion -- perhaps HK$160 billion following joint venture deals with Australian telco Telstra Corp -- and that PCCW will write down the amount all at once.
CASH IS KING
Several watchers said that while a negative equity position -- when liabilities exceed total assets -- sounds ominous, it would not have any operating impact on the company, whose share price has been devastated in the global tech and telecoms rout.
"From my perspective, who cares? ... All I care about is cash," said one fund manager who declined to be named.
But the fund manager said other investors might not regard a negative equity position kindly.
"In these types of markets, people are looking for bad news, and it might be perceived as bad news that a company has negative accounting equity. It couldn't be perceived as good news," the fund manager added.
While in some cases a negative equity position might violate covenants with lenders, PCCW's creditors -- who recently lent the company US$4.7 billion to refinance debt taken on to finance the takeover -- were no doubt aware of PCCW's potential negative equity, given that PCCW has itself raised the possibility in shareholder documents.
PCCW's lenders, analysts said, want to be sure the company generates enough cash to pay its debts -- which the company has often said it is able to do three-times-over.
Shares in PCCW, which soared to HK$28.50 in February 2000, were off 0.63 percent at the midday break on Monday at HK$3.925, below the psychological HK$4.00 support level it has maintained for much of this year.
NEGATIVE EQUITY
David Webb, a Hong Kong shareholder rights advocate, said: "It should not matter to shareholders, because it doesn't change the fundamentals of the business. It's just an accounting entry."
Webb added: "The treatment of goodwill on your acquisitions doesn't affect your cashflow at all."
The prospect of negative shareholder equity should not necessarily come as a surprise to investors, who were warned by PCCW in a December 22 document that under the firm's policy of "directly eliminating goodwill against the reserves, this acquisition (of Cable & Wireless HKT) is likely to lead to an overall net liabilities position for the group."
A report by Indosuez W.I. Carr analyst Greg Feldberg in November put the goodwill figure from PCCW's purchase of HKT at HK$190.4 billion (US$24.4 billion), valuing the firm's shareholder equity on September 30 at US$20.2 billion.
Feldberg said the widely-used accounting tradition of writing off goodwill can be misleading, because it implies that the asset -- in this case PCCW's core Hong Kong telecoms business -- cannot again be sold at a premium.
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