For Qwest, others, 'time to pay piper'
Goodwill revaluations mean write-down woes
By Aldo Svaldi
Denver Post Business Writer
Sunday, April 07, 2002 -
Qwest Communications International faces a historic write-off to comply with new accounting rules, but more than a dozen other Colorado companies are also vulnerable.
The rules, which took effect this year, require corporations to revalue an asset called goodwill. Companies create goodwill when they pay more for an acquisition than what the underlying assets are worth.
Of Colorado's 131 largest companies, 42 carry goodwill worth $55.8 billion. Thirteen have a fifth or more of their total assets represented as goodwill, leaving them vulnerable to write-downs.
A few, like Qwest, have told investors what the damage will be, but many have stayed tight-lipped even though a second-quarter deadline for disclosure is approaching.
Companies need to come clean and admit they overpaid for past acquisitions that failed to create value, said Will Hoover, president of The Will Hoover Co. in Cherry Creek.
"It is time to pay the piper," he said.
Many investors don't understand what has changed and why companies such as Qwest are forced to take the write-downs, said Rebecca McEnally, vice president advocacy at the Association for Investment Management and Research in Charlottesville, Va.
The changes are due to a new accounting rule, called Financial Accounting Standard 142, that requires companies to test their goodwill regularly and determine if it is impaired or lost its ability to generate cash for a company. Before, companies were required to write off goodwill in regular installments over as long as 40 years.
The new rules also tightened the method companies can use to value their goodwill, said Mike Power, an audit partner at KPMG in Denver. If the value of goodwill shown on the books is too high under that formula, companies must remove it from the balance sheet.
In return, companies can avoid depreciating goodwill as they did under the old system. Qwest, for example, will see a noncash gain of $900 million per year in its earnings.
"Goodwill represents resources expended to acquire operating capacity," McEnally said. "It is a cost, and it should not be ignored."
To use an automotive analogy, investors who paid $55,000 for what they thought was a Lexus are finding themselves stuck with a $20,000 Chevy Malibu. That difference has to be accounted for somehow.
Qwest, for example, will no longer be a $74 billion company, in terms of assets, but closer to $40 billion to $50 billion once the goodwill charges get taken in the second quarter.
Golden-based Graphic Packaging International Corp., estimates that up to $200 million of its $559.7 million in goodwill might be impaired.
But most Colorado companies haven't disclosed estimates for the write-downs they face on goodwill, even though they have had months to prepare for the new rules.
Denver-based Koala Corp. said some of its $28.6 million in goodwill - more than a third of total assets - might be damaged. UnitedGlobalCom Inc. of Denver warns that a "substantial" adjustment may be needed to its $4.5 billion in goodwill.
Englewood-based Crown Media Holdings Inc. expects a "significant" impact from the new rules on its $314 million in goodwill.
Englewood-based Mail-Well Inc., an envelope manufacturer and active buyer of printing plants, said it doesn't expect to know until December whether it'll have to adjust its $347 million in goodwill.
Power at KPMG said the companies need to pin down their impairments by June 30 or lose the chance to put the charges in a special and more favorable category related to accounting changes.
"Companies will be able to rightfully explain the write-down. How it got created will be tagged as a change in accounting," he said.
Companies who haven't determined an impairment charge by now either are avoiding the issue or, even worse, don't have a firm grip on estimates for their revenues and cash flows, said Lynn Turner, director of the Center for Quality Financial Reporting at Colorado State University.
"The most important issue when you see these write-downs is what is going on with the business that caused the write-down," Turner said.
McEnally said the new rules leave room for companies to determine the size of any write-down. Although the formulas are set, companies can plug in whatever assumptions they want into them, and there is no accounting standard regulating optimism.
"What the rule effectively does is leave it to management's discretion of when to recognize impairment and how much to recognize," she said.
When companies take a write-off, they predictably downplay its impact, accounting experts said. Companies argue that the impairment charges don't involve cash out of pocket and most often are a one-time event.
The experts disagree on how investors will view the write-offs.
Power doesn't expect much of an impact, but others argue the charges matter more than many investors realize.
"We reduce the asset, we reduce the earnings, we reduce the equity. The company shrinks," McEnally said.
A more fundamental question investors need to ask is why did executives overpay and what were they thinking, Turner said.
Power said nobody pays book value for a good company.
But during the late 1990s, companies overpaid because it was easier to buy the revenues and earnings growth Wall Street wanted rather than increase them internally.
Turner said chief financial officers have told him of a link between overpayment and an inflated stock price. "As long as an acquisition was stock, they fooled themselves into thinking there was no cost to it," he said.
Investment banker Hoover points to easy money flooding the market. Bidding wars produced an auction mentality. Companies that could boost their balance sheets also found they could borrow more.
But the days of mindless mergers are over - companies can no longer weave balance sheets out of thin air, Hoover said.
Companies will have to justify every merger and acquisition, as Hewlett-Packard is learning in its effort to take over Compaq.
"What is goodwill? I could make the argument for bad will," Hoover said. |
