New definition of goodwill: what we overpaid for the company

BVWireIssue #82-4
July 29, 2009

The pace of the current economic downturn appears to be slowing: The Dow Jones Industrial Average has inched upward from its low of 6,469.95 (on March 1, 2009) to hover at just over 9,000 (Tuesday’s close was 9,096.49, according to CNN). But the impact on the economy is “continuing to grow,” according to Edward Morris Jr. (Clifton Gunderson, LLP), who presented disappointing economic statistics during last week’s BVR teleconference, Goodwill Impairment in a Troubled Economy. Consider:

  • 53 banks have failed this year (as of 7-15-09) compared to only 26 in all of 2008.
  • Total U.S. bankruptcies are up 34.5% for Q1 2009 vs. Q1 2008; corporate bankruptcies are up 64.3% and consumer bankruptcies are up 36.5%.
  • Office vacancy rates hit 15.9% in Q2 2009.
  • National unemployment is at 9.5%, with the broader “U-6” rate (Bureau of Labor Statistics alternative measure of employee “underutilization”) currently at 16.5%.
  • Commercial real estate and credit card default rates are still climbing.
  • Bank goodwill write-offs are estimated at $25 billion in 2008 and $3.5 billion in Q1 2009, with an additional $290 billion still on the books.
  • Among the “top 20 write-offs” as of 12-31-08 are a few predictable sources (AIG at $3.2 billion, e.g.), but ConocoPhillips tops the list at $25.4 billion, and United Air Lines and its parent company post a combined $5.5 billion.

“You can expect more of the same” for the remainder of this year, Morris said, along with continued scrutiny of goodwill by the SEC, bank regulators, and the ubiquitous media. For example—a recent article in the New York Times presented an interesting definition of goodwill as “the amount [companies] overpaid for a business compared to the sum of its parts.”
What does this mean for valuation analysts everywhere? No matter if the subject company is public or private, “be more skeptical” when talking to management and reviewing forecasts, Morris advised. When a company’s market value (or a private company’s public comparables) diverges too far from a DCF analysis, suggesting an implied control premium in the range of 50% to even 90%, try sitting down to talk with management and “find a common ground.” For more on handling the implied control premia, discount rates, and adjusting debt values from Morris and fellow expert presenters Jim Alerding (Clifton Gunderson) and Brian Steen (Dixon Hughes), consider the teleconference “On-Demand” pack, including CD, transcript, and ancillary reading materials.

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