Accounting Changes Will Likely Roil Tech Company Stocks
By Jim Seymour
Special to TheStreet.com
01/25/2002 11:32 AM EST
I've been having an interesting email debate with a few RealMoney.com readers over the likely impact on the stock prices of AOL Time Warner (AOL:NYSE - news - commentary - research - analysis) and many other companies, mainly tech companies, this winter and spring, as they respond to the requirements of FASB 142.
Some say I'm unduly pessimistic. I think they're wrong. This is going to be a genuinely big deal -- and the day of reckoning grows nigh: most companies have to address these changes before the end of the second quarter.
As you may recall, changes in FASB rules mean companies can no longer take up to 40 years to gradually write off the difference between what they paid for an acquisition and its current real worth. This "goodwill" -- I've always chuckled at that term -- must now be dealt with promptly, meaning many businesses will be taking a huge one-time hit now.
A couple of weeks ago, AOL announced it will shortly take a charge it estimated at $40 billion to $60 billion for the reduced (read: real-world) value of its overpriced acquisition of Time Warner last year. Take $40 billion to $60 billion off the book value of a company like AOL, which has a current market cap of about $12 billion, and you have one heck of a drop in investors' apparent equity.
Safe Again
As I said in the Columnist Conversation Wednesday, I agree with my buddy Doug Kass, our Trading Diarist and a famous long-term AOL short, that with AOL selling below $30, most pricing worries have now been factored into the share price. So AOL once again looks like a fairly safe investment. (Doug not only covered his AOL shorts but even went a little long on the stock.)
And I meant that. I think AOL has a bright future -- though I worry about how aggressively it can cash in on the "convergence" we keep hearing about -- and I think it's a reasonable investment, advertising declines and the threat of the law of large numbers to AOL's subscriber growth notwithstanding.
The ads will come back, both in the company's many print publications and online -- and even better, the company has been successful in peddling cross-media advertising and marketing arrangements with the likes of American Express, Burger King and Sprint. The rapid growth in the number of AOL accounts that investors relied on in years past to drive up the share price may be dampened by the sheer size of the venture. With 33 million subscribers at year-end, AOL faces huge challenges in sustaining its historic growth rates.
I said in that earlier column that I think this FASB-mandated charge is going to freak a fair number of investors, who will wake up one morning to find the book value of their company is maybe half what it was when they went to bed. To be sure, this is a noncash charge and shouldn't fundamentally impede a company's operations.
But while Wall Street people know about the FASB changes, understand the nature of these charges -- and have, I think, pretty well factored into their valuations of "FASB companies" the impact of these bookkeeping changes -- an awful lot of smaller investors are not and will not be in that same boat when it comes to financial sophistication.
Domino Effect
Which means, at least potentially, that when these writedowns hit the fan, we're going to see some downward action from investors with smaller positions. If we get enough of that, it will force institutional investors, fund managers and others into defensive selling as well. Which will move the share prices of affected companies down still further.
That's the real risk I see remaining in AOL: that we'll see fluctuations, perhaps sharp ones, from FASB-charge-related panic-selling by small investors. (I should say that because I like AOL under $30, that obviously also means I'll see those drops as chances to average down, accumulating on the way.)
My correspondents have been arguing that investors today are far more sophisticated than that; they read the papers, watch CNBC and -- of course! -- closely follow TheStreet.com and RealMoney.com.
Well, sure, small investors are a lot better informed today than they were 10 or 20 years ago. The range, depth, quality and accessibility of information resources available are vastly greater. And many more investors take their investments seriously, I believe, today. Call it the 401(k) Effect.
Some of them will know all about the FASB changes and will have already made up their own little lists of companies they hold, which are likely to have to go through wrenching writedowns. But not all of them will have done so -- not even, I suspect, close to a majority.
Others in our little email roundelay point out that AOL was smart to be up front early about these charges, and has gotten a lot of press due to that forthrightness. In the process, they argue, the share-price risks have been diminished. Once again, yes. But the risks have only been reduced, not eliminated.
Big Trouble for Big Tech
Actually, despite the enormous numbers involved here for AOL, I'm less worried about AOL than about the long list of other companies -- mostly, big tech companies -- that face similar charges in the first couple of quarters of this year: companies that haven't been early or forthright or candid about upcoming charges.
Noncash or not, these charges are going to take a lot of shareholder equity off their books.
AOL is hardly alone here. Qwest (Q:NYSE - news - commentary - research - analysis), for example, carries $30.8 billion of goodwill on its books, from its acquisition of regional Bell operating company US West. With a book value of just over $37 billion, what will happen when that goodwill is charged off? This isn't an academic question: Qwest has to face this up to this sometime in the first half of 2002.
Or consider WorldCom (WCOM:Nasdaq - news - commentary - research - analysis), which with a book value of about $55 billion, is carrying more than $50 billion in "goodwill." Again, the clock is ticking. Both companies say they're studying the situation. I'll bet they are. So are investors.
Consider this a warning. I don't think investors can ignore concerns about how the market will respond to these unavoidable -- and now, no longer "delay-able" -- charges. Is it time, perhaps, to make a few calls to the investor relations offices of your largest holdings, asking some tough questions about writeoff plans? |
