Thursday, February 28, 2019

The examples below are only observations and are NOT to be construed as investment advice. Nor are these examples of good or bad transactions. They are simply observations and a collection of data for an analyst to use in drawing their own conclusions. This piece was originally written prior to the asset impairment reported by Kraft Heinz on February 21, 2019. We stand by the data and the story.

In order to enable a greater degree of transparency, visit our goodwill page to go through a few examples of acquisitions by large firms and how these acquisitions may be monitored through corporate filings in a systematic way.

A lot of bad feelings can arise from how companies handle goodwill.

That is unfortunate, because goodwill has become an increasingly large and important part of the corporate balance sheet. In our analysis of the S&P 500, we found that more than $3 trillion in goodwill now sits on the balance sheets of those firms (Table 1). Average amount of goodwill per filer has risen 35.4 percent in the last four years, from $5.1 billion in 2014 to $6.9 billion in 2017. In fact, the ratio of goodwill to assets across the universe now sits at 8.77% compared to just over 7% in 2014.

This means that questions about impairment of goodwill, and whether the goodwill paid in an acquisition has lived up to expectations, may have become more urgent. According to one famous study from 2011, at least 70 percent of M&A deals fail to achieve desired returns.1 The implicit criticism there is that acquirers either did not adjust goodwill in those deals downward with appropriate speed, or they simply paid too much for the target in the first place — and didn’t confront that fact until a painful impairment announced to investors.

It should be no surprise, therefore, that the International Accounting Standards Board (IASB) is considering allowing firms to write off a fixed amount of goodwill every year.2 A better analysis of goodwill is crucial to evaluating corporate performance, and to anticipating possible impairment of goodwill before it happens.

TABLE 1 : Goodwill and Impairment Over Time

2014 2015 2016 2017
Goodwill ($B) $ 2220 $ 2489 $ 2791 $ 3069
Firms with Goodwill 436 441 442 445
Avg. Firm Goodwill ($B) 5.093 5.643 6.314 6.898
Avg. Goodwill to Assets Ratio(%) 7.10% 7.84% 8.34% 8.77%
Firms with Impairment 57 69 69 72
Impairments ($B) $ 20.04 80.45* $ 24.61 $ 27.16
Avg. Impairment ($B) $ 0.352 1.166* $ 0.366 $ 0.377
*Energy complex write-downs in 2015 exceeded $55 Billion USD. Removing those brings the average impairment to $243 million per S&P 500 firm.

Initial Conclusion

Impairment numbers are going up, so are goodwill balances and the number of firms reporting both items. Given the trend, we can likely expect that losses from Impairment will grow into the future.

But we are far from finished. Is there anything that we can do to consider what may be coming down the pike?

As we stated in our disclaimer, while we are not in the advisory business, we are in possession of data that can better inform an analyst of potential outcomes.

The Devil in the Details

The topic is making its way into the press as well. The Economist quotes Hans Hoogervorst, the IASB’s chairman, “…many of the computers behind factor funds, a popular type of statistically driven investing, don’t adjust properly for goodwill.”3

At Calcbench, we would posit that an intelligent process be able to anticipate what is coming down the road. To show how this might happen, we combine data from the Business Combinations footnote with the information provided in Table 1. We would also systematically combine that data with segment disclosure information to help in determining the efficacy of the merger.4

Transparency is Good… a Procedure with Transparency is better

At Calcbench we believe that data transparency gives our clients (investor, analysts, academics and auditors) better methods and tools to help answer questions based on complex accounting pronouncements and their impact on financial statements.

4If an M&A transaction is material, the acquiring company must put the transaction through a purchase price allocation (PPA) process. At Calcbench, we collect and disseminate the data from the PPA in line-item detail. One of those line-items is goodwill per transaction.

FREE Calcbench Premium
Two Week Trial

Research financial & accounting data like never before. Get features designed for better insights. Try our enhanced Excel Add-in. Sign up now to try the Premium Suite.