Most of JDS's $51 billion loss was goodwill, not cash
BY SCOTT HERHOLD
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How can a company that had total revenues of $3.2 billion in its last fiscal year lose $51 billion? By what kind of math does JDS Uniphase's recent earnings statement make sense? Fifty billion dollars?
Glad you asked. JDS' stupendous paper loss is tied to its acquisitions strategy. And to understand just how that strategy got JDS where it is today, it's helpful to have a back-roads tour of American accounting.
What happened to JDS Uniphase (JDSU), the San Jose fiber-optics company, is a little like what might happen to a housekeeper in a country with rampant inflation and lousy bread.
Keen to obtain food, the housekeeper pays an outrageous amount for a loaf. When she gets home, she realizes it's mostly cardboard. She's distressed. But on the other hand, she's paid for the loaf with money that will be worthless tomorrow. One sham balances another.
In essence, that's what JDS was doing when it acquired companies over the past two years, most prominently SDL (SDLI), another San Jose fiber-optics components company.
On its face, JDS was paying an outrageous amount in its all-stock acquisitions. The SDL deal, for example, was valued at $41.5 billion when it was announced in July 2000, when JDS stock was selling for about $115 a share.
As business dwindled in fiber optics, JDS found those companies weren't worth anywhere near that much. With its stock price under $9, the company said so publicly last week. On the other hand, JDS paid with inflated currency, its own shares. One sham balanced another.
(A mea culpa here: When the SDL deal was announced, I wrote generally positively about it, predicting it would pass regulatory approval. It did. But I missed the big fiber-optics downturn.)
So how did we get to a $51 billion loss? It helps to understand a concept known as ``goodwill,'' which, alas, has nothing to do with being a decent human being.
Goodwill is particularly important for a company like JDS, which was built on acquisitions. It's the difference between what an acquirer pays for a company and what the acquired firm's real assets -- computers, property, cash, etc. -- are worth. If a company pays $2 million to acquire XYZ Widget but Widget's real assets are worth only $200,000, the goodwill is $1.8 million. In some sense, it's a measure of a company's good name.
Ordinarily, goodwill, as a depreciating asset, is written off over a period of years -- in the SDL case, over five years. That means a quarterly charge on the income statement.
An odd twist to the SDL acquisition made the goodwill number even more prominent -- and ultimately, punishing. Following accounting standards, JDS was required to value the deal based on its own stock price in the days around the July 2000 announcement. That pegged the transaction at $41.5 billion. SDL's hard assets -- plus certain other property -- were worth less than $2 billion. So goodwill was $39.5 billion.
By the time the deal was finally approved by federal regulators in February 2001, however, the fiber-optics market was collapsing. JDS stock had fallen by two-thirds -- and SDL's had gone down a like amount. The deal was now worth only $13.5 billion.
None of this cut any ice with the accounting rule makers. Though it was completing a $13.5 billion transaction, JDS was still left with three times as much goodwill on its balance sheet as the deal was worth. Every quarter, it was writing off roughly $2 billion.
``The basics behind the rule would be that the purchaser thought this was a good idea at the time of the announcement,'' says Andy Mintzer, a Santa Monica accountant familiar with SEC rules. ``So the purchase price should be tied to that decision.''
By early May, JDS was warning that it might have to take a huge accounting write-down. Its market cap had fallen below the assets it was carrying on its books, including goodwill. And last week, it announced a $44.8 billion write-down, bringing its loss for the year to $51 billion.
How much blame does JDS bear for this situation? Well, one theory is that because its acquisitions were generally stock-for-stock transactions, the company really didn't lose anything. Fifty billion in cash didn't walk out the door. Had JDS waited, SDL and other companies might not have been available.
``I feel very strongly that we're much better off,'' says Tony Muller, JDS' chief financial officer. ``I'd rather be in this downturn with the portfolio of businesses we have than be without them.''
On the other hand, the company is publicly conceding that the loaf of bread is filled with cardboard -- that it paid too much, at least in accounting terms. With a lot of cash on its balance sheet and nearly no debt, JDS is not badly positioned going forward. In my view, it's not a bad investment. But it's had to digest one of the world's more unappetizing meals. |
