Some of the world’s largest companies are facing multibillion-dollar write-downs on recent acquisitions as a wave of deal-making gives way to a new era of economic uncertainty and higher interest rates.
With a third of the global economy forecast to be in recession this year, world leaders will gather in Davos, Switzerland this week to discuss what the World Economic Forum has dubbed a “polycrisis” as business leaders embark on a painful reckoning with their empires. Building.
US media and healthcare companies have been among those to cut the value of business units in recent months, with accountants warning that more cuts could be coming as the annual reporting season gets under way.
Companies are required to estimate the book value of intangible assets at least once a year, using assumptions about future cash flows and comparisons with stock market valuations, which plummeted in 2022.
With higher costs due to inflation and weaker demand prospects, many recently acquired businesses may struggle to justify their valuations, even before factoring in higher interest rates, which further reduce the present value of future cash flows.
“It’s a pretty lethal combination,” said Jasmeet Singh Marwah, managing director of Stout, a valuation services company. “For many businesses. . . they procured and the performance was not in line with what they expected or planned for.”
Global dealmaking reached a record $5.7 billion in 2021, but slowed sharply as 2022 progressed. According to Refinitiv, $1.4 trillion in transactions were agreed in the second half of last year, compared with $2.2 trillion in the first, the biggest swing from one six-month period to the next since records began in 1980.
The premium paid for the acquisition above its net asset value is called goodwill and is recorded on the acquirer’s balance sheet. Goodwill write-downs soared in the US last year, to the point where they were occasionally large enough to wipe out a company’s profit in the quarter in which they were recorded.
The top 10 goodwill write-downs at S&P 500 companies totaled $35.4 billion in 2022, compared with $6.1 billion in 2021, according to data compiled by consulting firm Kroll.
Launching a bid to join Disney’s board this week, investor Nelson Peltz pointed to about $50 billion in goodwill on Disney’s balance sheet attributable to the Fox acquisition, which he predicted would have to be written down heavily.
Business and political leaders in Davos at the first WEF winter meeting since before the coronavirus pandemic face a completely different landscape compared to three years ago.
Ahead of the meeting, the WEF’s annual risk report warned of a “polycrisis” as rising living costs and economic decline combine with continued failure to tackle inequality and climate change.
Kristalina Georgieva, the IMF’s managing director, who will be in Davos to present the fund’s latest economic outlook, predicted earlier this month that one-third of the world economy will be in recession this year, including half of the EU.
The size of goodwill write-downs in Europe has not increased so far. The top ten in the Stokk 600 totaled 6.4 billion euros last year, according to Kroll, down from 17 billion euros in 2021.
European companies have later financial years and report less frequently, said Carla Nunes, managing director of Kroll, suggesting there could be more goodwill erosion in the spring.
Dan Langlois, a partner at KPMG, said recent acquisitions could be subject to write-downs even if they are currently working according to plan.
“When you factor in cost inflation that may not have been anticipated, when you factor in higher interest rates, which increases the rate that you might use in the discounted cash flow analysis, and then factor in some of the uncertainties associated with a potential recession, those things will overall affect the fair value,” he said.
In October, Comcast reported a more than $8 billion write-down of broadcaster Sky, which it bought in 2018, citing challenging economic conditions in the UK and other European markets and pushing the media group into a quarterly loss of $4.6 billion.
Earlier last year, Teladoc Health, which acquired virtual care Livongo for $13.9 billion in 2020, posted two consecutive quarters of write-downs totaling close to $10 billion.
While companies are required to deduct goodwill write-offs from their profits, many exclude them from the “adjusted” numbers they report on earnings reports.
That doesn’t mean investors should ignore them, said David Zion, founder of Zion Research.
When a company reduces the value of its assets, its debt-to-equity ratio rises, which in turn increases the risk of default on its debt, he said. It can also flatter future returns.
“Management will tell you it’s cashless, it’s one-time, don’t worry about it.” Don’t forget that when the return on assets is so good two years later, it’s because they had a huge write-down.”
Kroll’s Nunes added that the decline in goodwill gives a read on the quality of the company’s dealmaking. “You can tell if you’re getting a return on your investment,” she said, “or if the customer might be overpaying for these jobs.