Friday, January 23, 2009

Goodwill: Phony Asset

When reading about corporate acquisitions, we often discover that the acquiring company pays a premium over the stock market value to take over a company. This is done to entice the seller to pony up the entire company and avoid proxy fights and extended negotiations.

The peculiar thing is that, according to Generally Accepted Accounting Principles (GAAP), this results in an asset called goodwill on the books of the buyer. I guess the idea is that the buyer will realize synergistic benefits from the combination and should be more highly valued.

What happens if the acquisition stinks? Shouldn't this goodwill asset be written down? The answer is yes. Several companies have written down the value goodwill (an asset that does nothing) in the last few months:

Regions Financial (NYSE: RF) - $6 billion write down reported on 1/20/09

National City Corp. (NYSE: PNC) - $1.34 billion write down reported on 11/6/08. Nat City was acquired itself by PNC on, I think, 12/31/08.

Royal Bank of Scotland (NYSE: RBS) - estimated GBP 17.5 billion ($24.15 billion) for year end 2008. RBS is also expected to report a total loss of $41 billion for 2008, the largest loss in U.K. history.

With the current performance of the financial markets, it is hard to believe that goodwill is worth much of anything. writing it off, although not explicitly consuming cash, does delete capital. Capital is a scarce resource. Regulators have discussed liberalizing the valuation of this nonsense asset to stabilize banks and ease capital stress.

Based on numbers reported on 9/30/08 for banks with over $10 billion in assets:

- Goodwill accounted for 3.13% of total assets: $302.8 billion

- Equity capital accounted for 9.42% of total assets: $910.5 billion

So, 33.26% of capital is a phony asset. Will you sleep better tonight?

Please click below to expand.

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