Is too much goodwill a bad thing?

Brian C. Hedges, BridgeTower Media Newswires

To almost anyone but attorneys, investment advisors, and accountants, goodwill may mean friendliness. Cooperation. Altruism. However, to those attorneys, investment advisors, and accountants, goodwill on a corporate balance sheet is an indication of corporate optimism. Synergies. Future profits.

Goodwill is the excess in the purchase price for a business acquisition above the fair value of the assets that the acquirer receives, less the debt assumed. Since 2009, the value of corporate goodwill is reminiscent of a roller coaster click-clacking its way up to the hill’s peak. The ride below — the timing and/or severity — is one that is anyone’s guess.

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Examples of goodwill

Below are two simplified examples of goodwill from different types of businesses — both may have goodwill to an interested acquirer:

Example No. 1: An internet marketing business has a few aging laptop computers and A/V equipment, but it includes a group of talented professionals serving a diverse client base across the Northeast.
A company interested in acquiring this growing business will likely pay more than the few thousand dollars of the fair value of the equipment. The difference between the value of these assets and the purchase price should be recognized as an intangible asset, the largest of which may be goodwill.

Example No. 2: A machine shop located in Upstate New York has a strong client base around the region (the “Target”). A competing machine shop from out of state is executing its strategy of acquiring smaller machine shops and is looking to acquire the Target to gain a foothold in New York. As the acquiring business sees synergies in the operations (e.g., reduce administrative expenses), it will likely value the Target in such a way that the payment to the Target far exceeds the value of the Target’s assets giving rise, in whole or in part, to goodwill.

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The goodwill roller coaster ride ... up

Over the last 10 years, U.S. publicly traded companies have roughly doubled the aggregate goodwill values on their balance sheets — by continuing to buy companies at values above the tangible asset (and identifiable intangible asset1) values on their balance sheets. The trend of multi-billion-dollar acquisitions have been driven in large part by a troika of: (1) sustained low interest rates, (2) a decade-long bull market, and (3) cash-rich investors.

To study the impact of companies with goodwill and other identified intangible assets, with the help of a private family office Chief Investment Officer, I have prepared a study of 2,254 companies that have reported goodwill and other intangible assets for every quarter since July 2009.

To develop an aggregate goodwill value at privately held companies, there is no telling how the value and/or its growth compares to these 2,254 publicly traded companies. The lack of reporting requirements for private companies do not allow for a similar study. Nonetheless, a similar trend would not surprise me, given the transactions I have seen in my practice.

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The goodwill roller coaster ride ... down

At current, at least once per year, a public company with goodwill must assess whether its goodwill is impaired. If the carrying value of the assets from an acquisition on a company’s balance sheet exceeds the recalculated fair value of the assets, the company must write down the goodwill and take a loss in its quarterly or annual reporting cycle — known as a goodwill impairment. Two companies with household name recognition are below:

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General Electric’s impairment

One of the largest goodwill impairments in the last 10 years is General Electric’s (“GE”) $22.0 billion impairment from 2018. GE disclosed the following in its December 2018 10-K: “Our outlook for [our] Power [sector acquisition] has continued to deteriorate driven by the significant overcapacity in the industry, lower market penetration, uncertain timing of deal closures due to deal financing, and the complexities of working in emerging markets. In addition, our near-term earnings outlook has been negatively impacted by project execution and our own underlying operational challenges. ... These conditions resulted in downward revisions of our forecasts on current and future projected earnings and cash flows...”

Large misses such as these shake investor confidence, which GE has largely struggled with (as reflected in its stock price) since mid-2017.

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Is AT&T at risk?

A recent article from Sandra Peters at the CFA Institute2 showed a table of the 41 publicly traded companies with goodwill over $20 billion, the leader being AT&T Corp with over $146 billion in goodwill.
AT&T’s goodwill jumped during 2018, with its acquisition of Time Warner and the $38.8 billion in goodwill.3 Along with Time Warner, AT&T’s acquisition of DIRECTV represents two of the largest 25 publicly reported acquisitions during the 2010s. Both present a challenge for AT&T to continuously support the value paid through any potential economic downturn, which may impact AT&T’s future outlook.

For AT&T, a telling date this year will be after October 1, 2020, when AT&T calculates its goodwill, per its 10-K filing. Any results would be communicated at a minimum in AT&T’s annual 10-K filings, if not quarterly. In AT&T’s limited earnings announcement for the year ended Dec. 31, 2019, there was no mention of a goodwill impairment relating to the Time Warner or DIRECTV acquisitions. As of the submission of this article, AT&T had not yet filed its 2019 10-K.

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When is said downturn?

The tipping point for goodwill impairments is generally the decline of forward-looking projections, which in part are macroeconomic in nature or event-driven items. There are many indication signs at a macro-economic level that point to the top of the roller-coaster ride, leaving large goodwill impairments and corresponding stock price declines to follow. All we can do at this point is wait and see.

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Brian C. Hedges, CPA, CFE, CVA is a partner in Mengel Metzger Barr & Co. LLP’s Transaction Advisory Services division. He consults with business owners to determine the value of their businesses and he helps with buy-side and sell-side due diligence for businesses looking to buy or sell businesses around the country.
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Footnotes
1When accounting for purchases at Fair Value, companies may separately value intangible assets as assets that are being acquired. Such examples of these intangible assets include: (A) customer lists, (B) key distribution relationships, and (C) trademarks & trade names.
2Peters, Sandra; “FASB Turns Up the Heat on Goodwill Impairment Testing”, CFO.com, February 12, 2020 (https://www.cfo. com/accounting-tax/2020/02/fasb-turns-up-the-heat-on-goodwill-impairment-testing/).
3AT&T Corp. 10-Q filing for the period September 30, 2019. (Refer to: https://investors.att. com/financial-reports/sec-filings). In addition to the Time Warner acquisition, AT&T’s goodwill of $146 billion is driven by its Bell South acquisition in 2006 (approximately $54 billion) and the DIRECTV acquisition in 2015 (approximately $35 billion), plus the Time Warner acquisition.