Northrop Grumman Corp. (NOC), the world’s largest warship builder, recently took a goodwill impairment charge of $3.1-billion in the fourth quarter for acquisitions made back in 2001 and 2002. Several other companies have made similar announcements recently, but Time Warner Inc.’s (TWC) C$25-billion writedown really put the issue back on people’s radars.
Among other periods, the buildup of goodwill and intangible assets on corporate balance sheets became an issue during the dot-com bubble. So with earnings season in Canada gearing up next week, the market is keeping a lookout. Desjardins Securities reviewed every member of the S&P/TSX composite index to identify those with abnormally high goodwill and/or intangible asset exposure, which may be at risk of similar writedowns.
Desjardins vice-chairman Peter Gibson told clients:
Although intangibles play an increasing role in corporate operations, and are justifiably recognized on the balance sheet, the value of these assets is highly subjective and open to management discretion.
He isn’t all that concerned with high intangible exposure on its own. Rather, the firm is looking for companies that have abnormally high exposures relative to the norm for their sector or have grown intangibles at a faster rate than tangible assets. Firms that have not reported any intangible or goodwill writedowns are also targeted.
Knowledge economy industries like healthcare, information and consumer sectors typically hold 30% to 50% of assets in the form of intangibles. Meanwhile, energy, materials, utilities and financials report intangible exposures of 10% or less. Commodity producers, for example, derive value from physical assets such as commodity reserves, property, plants and equipment.
So what did Desjardins find out about Canadian companies? In every sector except healthcare, goodwill accounts for a larger proportion of assets than intangibles. The firm is more skeptical of goodwill.
Mr. Gibson said:
Several firms have significant goodwill balances due to recent acquisitions – while not intrinsically problematic, if takeovers occurred at far higher valuations than presently available, it may be difficult to justify carrying values. This is, of course, fact-specific, but given market conditions in recent months, it would not be unreasonable to expect some degree of impairment.
Here is a selection of Desjardins’ findings:
- Sector: Healthcare Company: CML Healthcare Income Fund Proportion of assets in the form of goodwill or intangibles: 83% Points of interest: It has not written down any of these assets this year and intangible growth has exceeded tangible growth. However, a significant proportion of the company’s assets are licenses, the value of which depends on contractual terms.
- Consumer discretionary Yellow Pages Income Fund (YLWPF.PK), 93%. Sector average is 38%. While the company has not written down any of these assets, tangibles have grown at a faster rate.
- Consumer discretionary Telus Corp. (TU), 43%. Tangible assets have been growing at a faster rate than intangibles. Level of intangibles is not high compared with other firms in the index, but represents the largest exposure in the telecom sector
- Consumer staples Metro Inc. (MTRAF.PK), 41%. Shoppers Drug Mart Corp. (SHDMF.PK), 42%. Both have tangible assets growing at a rate roughly twice that of intangibles.
- Financials TMX Group Inc. (TMXGF.PK) After the merger between the Toronto and Montreal stock exchanges, TMX’s goodwill and intangibles increased dramatically – a 236% annualized rate versus 27% for tangible assets.
- Materials Labrador Iron Ore Royalty Income Fund (LBRYF.PK), 55% (intangibles). A large portion of this is in the form of royalty agreements.