Some of the world’s largest companies are facing multibillion-dollar writedowns from recent acquisitions as a wave of deals give way to a new era of economic uncertainty and higher interest rates.
With a third of the global economy expected to be in recession this year, leaders are set to gather in Davos, Switzerland this week to discuss what the World Economic Forum has dubbed a “polycrisis,” while business leaders discuss a make painful reckoning over their empire building.
U.S. media and healthcare companies are among those that have slashed the value of business units in recent months, and auditors warn that more cuts could be imminent when the annual earnings season begins.
Companies must determine the carrying value of intangible assets at least annually using assumptions about future cash flows and comparisons to stock market valuations, which have fallen sharply in 2022.
With higher costs due to inflation and a weaker demand outlook, many recently acquired companies may struggle to justify their valuations before factoring in higher interest rates that further reduce the present value of future cash flows.
“It’s a pretty deadly combination,” said Jasmeet Singh Marwah, chief executive at Stout, a valuation services company. “For many companies . . . They made the acquisition and the performance did not meet their expectations or budget.”
Global dealmaking hit a record $5.7 trillion in 2021 but slowed sharply throughout 2022. According to Refinitiv, deals worth $1.4 trillion were agreed in the second half of last year, compared with $2.2 trillion in the first, marking the biggest jump from one half to the next on record in represents year 1980.
The premium paid for an acquisition over the value of its net assets is known as goodwill and is recorded on the acquirer’s balance sheet. Goodwill amortization has increased in the US over the past year, to the point where it has occasionally been large enough to wipe out a company’s profits for the quarter in which they were recorded.
The 10 largest goodwill writedowns at S&P 500 companies in 2022 totaled $35.4 billion, according to consultancy Kroll, compared to $6.1 billion in 2021.
Investor Nelson Peltz, who this week made an offer to join the Disney board, raised the company’s value by about $50 billion.
Business and political leaders in Davos for the first winter meeting of the WEF since the pre-coronavirus pandemic are faced with a vastly different landscape than three years ago.
Ahead of the meeting, the WEF’s annual risk report warned of a “polycrisis” as rising living costs and an economic downturn 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 a third of the global economy will be in recession this year, including half of the EU.
The level of goodwill amortization in Europe has not increased so far. The top 10 in the Stoxx 600 totaled $6.4 billion last year, up from $17 billion in 2021, according to Kroll.
European companies have later fiscal year ends and less frequent reporting, said Carla Nunes, chief executive officer of Kroll, hinting that further goodwill impairments could occur in the spring.
Dan Langlois, a partner at KPMG, said recent acquisitions could be prone to writedowns, even if they currently go as planned.
“When you include cost inflation that may not be expected, when you include higher interest rates that push up the interest rate you might use in a discounted cash flow analysis, and then account for some of the uncertainties associated with a potential recession , these things overall will affect fair value,” he said.
In October, Comcast reported a more than $8 billion writedown on broadcaster Sky, which the company acquired in 2018, citing difficult economic conditions in the UK and other European markets and plunging the media group to a 4.6-quarter loss billion dollars.
Earlier last year, Teladoc Health, which acquired virtual care provider Livongo for $13.9 billion in 2020, recorded two consecutive quarters of total writedowns totaling nearly $10 billion.
While companies are required to deduct goodwill amortization from their earnings, many exclude them from the “adjusted” numbers they highlight in earnings reports.
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That doesn’t mean investors should ignore them, said David Zion, founder of Zion Research.
When a company falls in the value of its assets, its debt-to-equity ratio rises, which in turn increases the risk of breaching covenants on its debt, he said. It can also flatter future returns.
“Management will tell you it’s non-cash and one-time, don’t worry about that. Don’t forget that the return on investment two years from now is so good because they have taken a huge depreciation.”
Von Kroll added that goodwill impairment is a measure of the quality of a company’s business. “You can determine if your investment is paying off,” she said, “or if the buyer is potentially overpaying for these companies.”