Re: You CANNOT "write up" the value of existing assets.
I never said they did, nor meant to imply such.
But it is quite easy for a company in a capital intensive industry to inflate the balance sheet assessment of its aggregate PP&E. In fact, it's actually difficult not to.
Companies in capital intensive industries must continually upgrade their PP&E, or they cease being competitive. Sometimes they also make acquisitions for growth or to gain new technology. Since these costs are capital costs, they are generally not immediately included as costs when the company calculates its earnings. In the case of some acquisitions, the costs are for intangibles and are called goodwill. But for both PP&E and goodwill, even though value accrues to the company that can persist for some time following the quarter of the expense, they are costs, and the money spent is gone.
The way in which these costs are accounted for is to apportion them out over the expected life of the PP&E or goodwill, and charge a fraction of the total cost each quarter - that way the capital and acquisition costs eventually show up in the earnings statements as depreciation and amortization charges taken against earnings.
Inflation of the valuation of the PP&E occurs if the value of these assets is charged more slowly than the actual rate at which they decrease. The nature of high tech is that plant becomes obsolete very quickly, and the cyclical nature of the business means that otherwise valuable plant can become surplus overnight - and be obsolete and worthless before business pick up again. Ideally, a company in such a business will be conservative in the valuation of its PP&E, taking sufficient charges to keep the book value of its PP&E in line with its real value. If it doesn't, it runs the risk of finding itself in the position of NT - and having to take a huge writedown in a single quarter.
AMD has generally been conservative in its accounting, it depreciates quarterly roughly as much as it spends quarterly on capital equipment. If its book valuation starts to get ahead of depreciation - which frequently happens to all tech companies when technical or market factors render equipment obsolete ahead of initial expectations - AMD takes an extra writedown. We saw that this quarter when AMD took extra charges to account for what it saw as the earlier than expected obsolescence of two older FABs. AMD took charges this quarter some of which it won't incur for two quarters.
Another great example of conservative accounting was AMD's acquisition of Nexgen. Even though it paid for the acquisition with stock, so there were no "out of pocket" costs for AMD, then or ever, for "buying" Nexgen, AMD felt that the listed book value of Nexgen's assets was too high, so it took a writedown ensure that its undepreciated PP&E did not become inflated above its actual value (the value of Nexgen's assets were added to AMD's as a result of the merger).
Contrast that conservative accounting style with Intel's very liberal accounting. Despite forecasts of flat demand for the visible future, Intel has allowed the book value of its PP&E to increase by about $5 Billion this year. Had this been the result of a significant, permanent, expansion of capacity to meet significant expanded demand that increase would have been warranted.
I believe that a more accurate appraisal of what transpired during the past two years is that they were forced to accelerate the rate at which they replaced older equipment, in order to fight off AMD's rapid market share gains. Which means that the $5 Billion wasn't spent on expansion, it was spent on replacement, and that an additional $5 Billion in writedowns should have been taken to account for the early obsolescence of the equipment that was replaced.
This is what I was referring to when I expressed the opinion that Intel had inflated the value of its PP&E.
The other issue is the $6 Billion in goodwill they added to their balance sheet as a result of their acquisitions during the past 2 years. They certainly don't appear to be getting above market returns from the "other" category, so it doesn't seem to me to be reasonable to be listing goodwill worth $6 Billion on their balance sheet. Compare AMD's conservative immediate writeoff of the doubtful aspects of the Nexgen merger with Intel's very liberal taking of $6 Billion as goodwil instead of listing as costs the money they spent on various acquisitions during the period.
They have expensed a few of those costs already, but I still see an "extra" $9.5 Billion in costs sitting on their balance sheet that will have to be expensed over the next few years. That works out to about $1.42 per share more in GAAP earnings they have to earn over the next 4 years than they would have otherwise. Given that they'll be lucky to earn that much over the next 2 years, I think Intel has an accounting problem.
AMD has (relative to Intel) a very clean balance sheet. They won't have to take higher charges during the next few years to account for charges not taken last year and this year.
By the way, thinking about this brings to mind the opposite issue: companies in industries like agriculture that pay to acquire farmland, depreciate it down to $0 over 40 years, but are then holding an asset with a real value 10 or more times its original cost.
Accounting for costs in capital intensive industries is difficult, even with the best of intentions. An Ag company could report losses year after year, even as its actual value increased each year, while a tech company could report high earnings year after year, and suddenly be bankrupt. |
