Security Analysis and Business Valuation on Wall Street,: A ... - lib

The Limitations of Accounting Data 159in the stock market on a day-to-day basis. Most companies trade at a multiple of nettangible accounting value. Trademarks, reputations, patents, customers, distributionsystems, employees, <strong>and</strong> production processes are just a few items lending goodwillto a business.Firms assess the value of goodwill on an annual basis. The typical practice isa big-bath write-down when goodwill is impaired, rather than gradual charge-offs.In 2008, Sprint posted a $30 billion loss upon writing down the value of its NextelCommunications acquisition.The trick for active acquirers is to place acquisition value mostly in goodwill,rather than identifiable intangible assets, because goodwill is not amortized. The SEChas gotten wind of the practice, <strong>and</strong> it has an informal guideline that goodwill not representmore than 60 percent of the excess purchase price over a target’s book value.Identifiable Intangible Assets Under GAAP, as noted earlier, firms capitalize thevalue of an acquisition’s customer relationships, mailing lists, research <strong>and</strong> developmentcosts, leasehold interests, contractual rights, software, patents, <strong>and</strong> shelf space,among other items. Even with the help of professional appraisers, companies <strong>and</strong>auditors have problems in establishing fair value <strong>and</strong> economic life for these assets.Liabilities <strong>and</strong> Stockholders’ Equity Hidden liabilities <strong>and</strong> lowball estimatespresent problems in business valuations. We cover major liability categories here.Short-Term LoansAccounts Payableto manipulate.This is a difficult item for executives to manipulate.Short of outright fraud, accounts payable balances are difficultLong-Term Debt To reduce perceived financial risk <strong>and</strong> to enhance access to debtfinancing sources, corporations like to understate their true leverage positions. Directdebt financing often has the lowest cost, but it appears prominently on the balancesheet. Accordingly, companies seek alternative sources of debt-like financings such aslong-term operating leases, supplier credits, <strong>and</strong> off-balance-sheet transactions. Theanalyst can get a grip on operating lease exposure by investigating the footnotes, butoff-balance-sheet deals are harder to figure out.Lenders to securitization <strong>and</strong> project financings typically turn to a specific assetbase when things go bad, but in many deals lenders have subsequent recourse to thelead sponsor (i.e., the analyst’s subject of study). Rather than outright guarantees, thesupport arrangements involve nomenclatures that mean the same thing (e.g., a projectmay have a working capital maintenance agreement, “first loss” coverage protection,or take-or-pay contract). Due to legal <strong>and</strong> accounting nuances, many supports don’tqualify as outright debt, but in judging the economic value of the sponsor, theanalyst must consider their potential impact on corporate performance. Debt ratingagencies, for example, usually capitalize leases <strong>and</strong> consolidate off-balance-sheetfinancings (along with related assets) in calculating a firm’s total debt picture.From time to time, management is able to hide debts <strong>and</strong> keep them fromappearing on the balance sheet. Sc<strong>and</strong>als at Italian food conglomerate Parmalat <strong>and</strong>at cable TV giant Adelphia Communications involved billions in undisclosed loans.