G & M Article By MATHEW INGRAM
Globe and Mail Update
You might think that misplacing $40-billion (U.S.) or so would be a difficult thing to do, no matter how big your company is — that's more than the market capitalization of BCE, or the Royal Bank and TD Bank put together, or the national budget of Russia. And yet, fibre-optic equipment maker JDS Uniphase must have managed to lose that much money somehow, right? That's why they're talking about a $40-billion writeoff.
It's not quite that simple, unfortunately. Of course it's fortunate for JDS and its shareholders that the company didn't lose $40-billion in actual dollars, but the idea behind the "write off" of $40-billion is a complicated one, involving accounting standards and "book value" and so on — and that can make it difficult for investors to figure out what it means when a company like JDS makes a statement like that.
Balance-sheet accounting in general, of course, is so dry that it could put an inanimate object to sleep, and the issues surrounding writeoffs of "goodwill" in corporate takeovers are even more arcane. But it's important for investors to understand what these writeoffs mean — and what they don't mean — because there are going to be more of them. Most will be from technology companies, although it's unlikely that any of them will crack the $40-billion level (AOL Time Warner is carrying about $158-billion in goodwill, but it will write that off gradually over the next 20 years).
The reason so many tech companies have these kinds of writeoffs is directly related to the spectacular growth the Nasdaq stock market saw over the past two years, with companies like JDS and Cisco Systems and Nortel tripling and quadrupling their market value — and then using their high-flying stock as currency to acquire other companies. Cisco and Nortel have both spent in excess of $30-billion over the past several years in order to buy various companies with promising fibre-optic technology.
Most of the writeoffs that JDS is looking at are related to a few major deals: the $4-billion merger of Canadian-born JDS Fitel with U.S. competitor Uniphase Corp. in 1999 was one; another was the $17.5-billion purchase of E-Tek Dynamics last year; the third was the recent takeover of fibre-optic firm SDL Inc., which was valued at $41-billion when first announced. As the share price of both companies plummeted, so did the value of the deal, and by the time it was concluded it was worth $13.5-billion.
At the moment, JDS says that it has $56-billion in "goodwill" on its books as a result of those deals. The reason analysts are talking about $40-billion as a "writeoff" is that the amount of goodwill exceeds JDS Uniphase's current market value by about $40-billion. That means in order to bring its market value into line with the actual "book" value of its assets, the company will have to write off $40-billion or so in goodwill. But despite the huge dollar figure involved, it isn't quite as bad as it sounds.
That's because goodwill is a purely theoretical thing, almost an accounting abstraction. JDS never had that $56-billion to begin with, and never really spent it — that figure simply represents the difference between what JDS paid to acquire those assets, and what they are recorded as being worth on the company's balance sheet. If a company pays more than a takeover target's actual assets are worth, the difference is referred to as goodwill, since it often includes intangibles such as the value of a company's brand or the fact that the company has a good reputation.
So is taking a $40-billion writeoff bad? In a way, yes. It means that JDS paid too much for the assets it bought — goodwill isn't supposed to represent such a massive amount of a purchase price. However, because JDS bought these other companies with its own stock, it isn't as bad as if it had paid with actual money. Existing shareholders do suffer some damage because each takeover involves new shares being issued, which dilutes the per-share earnings and cash flow of the company. But the takeovers are also expected to make the company more valuable at some point as well.
Accounting standards bodies in the United States and Canada are working on changes to the national requirements in each country when it comes to goodwill, which should make it easier for shareholders to understand what is going on when takeovers occur. Under the new rules, goodwill writeoffs would only be required if the assets were permanently "impaired," meaning the likelihood of them producing value was negligible.
What this means is that investors will be able to see more clearly what kind of earnings and cash flow a company is getting out of the assets it buys. Some critics argue that it will fuel the trend toward larger and larger mergers, because companies would no longer be put off by the massive writeoffs they would incur. At the moment, analysts often look at confusing acronyms such as EBITDA (earnings before interest, taxes, depreciation and amortization) or phrases such as "cash earnings," because the writeoffs that companies like Nortel take obscure the bottom line.
Some critics argue that the changes will fuel the trend toward larger and larger mergers, because companies would no longer be put off by the massive writeoffs they would incur. Still, in the end it should make matters clearer for the investor, and that's good.