 Focus : European Cos Face Goodwill Hits As Stocks Slide |
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PARIS (Dow Jones)--With recession biting and stocks continuing to slide, acquisitions made by European companies at the height of the M&A boom over the last four years could become a time bomb as IFRS accounting rules are likely to force some businesses into heavy goodwill impairments when they report full-year earnings at the beginning of next year.
International Financial Reporting Standards, tied to broad principles, have been used by European and most other countries since 2005, but this year marks the first time they will be implemented against the backdrop of a sharp economic slowdown and a heavy stock market selloff, accountants and experts say, warning that companies could take a severe hit as a result.
This could in turn have an impact on the real economy by cutting into companies' equity and restraining their ability to invest for the future.
"It's the first time those rules will be tested in a bear market," said Marc Gerretsen, partner at accounting firm PricewaterhouseCoopers in Paris.
As global markets continued to fall, European groups have become worried about the impact of the stock market meltdown on the fair value of assets acquired at high prices during the M&A boom, Gerretsen said.
The sharp deterioration of economic conditions, with the euro-zone slipping into recession in the third quarter, will also prompt companies to take a hard look at the value of assets they bought recently, since it will likely constrain their ability to generate future cash flow - another key parameter used to calculate value.
Gerretsen said he is now talking to clients about how to grapple with the problem, although "we're not yet at the stage where we are putting figures on potential goodwill impairments," he said.
"We will see how the IFRS rules on goodwill impairment are applied in the current stock market reversal. The results could be ugly," warned Nicolas Veron, an economist with think-tank Bruegel. He said this could translate into heavy losses for shareholders.
The stakes are high. In Europe, the total amount of goodwill for companies included in the DJ Stoxx 600 index is around EUR1,000 billion, according to the latest data disclosed by companies. This compares with a total market capitalization of EUR3,507 billion for the index as of Friday's close, down 50% since the start of the year.
In France alone the total amount of goodwill for companies included in the SBF120 stock market index reached EUR350 billion at the end of June, with companies having spent heavily on acquisitions over the past few years. Topping the list are the likes of telecommunications giant France Telecom (FTE), Sanofi-Aventis (12057.FR) and Vivendi (12777.FR). France Telecom's goodwill at the end of the first half was EUR31.6 billion, while Sanofi's and Vivendi's were EUR26.4 billion and EUR20 billion respectively - although accountants caution that companies with the highest goodwill will not necessarily incur the biggest write-downs.
The overall goodwill for SBF120 listed companies compares with a total market capitalization of EUR841.5 billion for that index at Friday's close. Since the start of the year, the index has lost 49%.
Goodwill shows up on a company's books when it acquires another company, for which it has paid more than the book value of its assets. The excess paid - minus allocation to fair value of assets and liabilities - is defined as goodwill and is added to the acquiring company's balance sheet as an asset.
Under IFRS rules, companies have to carry out goodwill impairment tests on an annual basis to determine whether the value of what they have acquired needs to be written down, either because of a drop in fair value linked to market prices, or because their ability to generate future cash flow has decreased. These tests can take place more than once a year if "major events point to loss of value," explained PwC's Gerretsen.
This is a major departure from previous French accounting rules, under which goodwill was amortized on a linear basis every year. Under that system a portion of goodwill was written down every year by a set amount over a defined time period, until it eventually dropped to zero in the company's books, effectively making the depreciation process relatively painless for companies.
"At the end of this year, it's going to be hard for companies to ignore several months of plummeting stock prices. Under IFRS rules, the pressure for companies to write down the value of assets acquired through business combinations doesn't diminish over time," said Yann Magnan, managing director at Duff & Phelps, a U.S.-based independent valuation advising firm.
Assessing whether and to what extent goodwill needs to be impaired is crucial for companies, as the decision, once made, is irreversible. This has far-reaching consequences because goodwill impairments eat directly into the companies' equity at a consolidated level.
This in turn could have an indirect impact on corporate investment, by increasing companies' leverage - the amount of debt they carry compared with equity - and that could eventually restrain their ability to borrow, warns Magnan.
"The sharp fall in stock markets could have a real impact via mark-to-market accounting methods which force companies and pension funds to book unrealized losses, which they then have to make up for by selling assets or cutting back on investment spending," said Keith Wade, chief economist at Schroders.
-By Nathalie Boschat, Dow Jones Newswires; +33 (0)1 40 17 17 40; nathalie.boschat@dowjones.com
Click here to go to Dow Jones NewsPlus, a web front page of today's most important business and market news, analysis and commentary: http://www.djnewsplus.com/al?rnd=XArlKZdU3IpnWbzCSPbKCA%3D%3D. You can use this link on the day this article is published and the following day.
(END) Dow Jones Newswires
November 24, 2008 04:53 ET (09:53 GMT)
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