Asset Values to be Cut

The Australian Financial Review had a front page story yesterday headlined "Dividends hit as asset values plunge",

It started "Shareholder dividends will come under increased pressure this reporting season as large companies are forced to write-off billions of dollars in goodwill built up over a decade-long merger acquisitions boom". (We won't force you to pay for the rest of the story at the AFR.com website.)

That opening paragraph should be a warning signal to readers about the rest of the story.

Why should a write-down in the value of a non-cash asset such as goodwill produce a fall in dividends?

It’s the fall in the profitability and cash generating ability of those assets that will cause a fall in earnings and therefore any cut in dividend payments.

Non-cash write-downs have no impact on the operating performance of company except where they push the company towards or into a breach of loan covenants with lenders.

Non-cash write-downs in asset values don't come off the profit and loss account: it's write-downs in the value of assets such as loans made by banks, which have to be paid for via the profit and loss account.

That's what is happening to the Commonwealth Bank at the moment where Goldman Sachs JBWere estimated yesterday that the bank's 2009 earnings will fall by more than 20% because of higher provision and write-offs of loan values and credit losses.

In the case of Allco Finance Group, where write-downs are going to finally produce a negative value for the company, the profitability and dividend payments vanished when the credit crunch hit and cut deals and fees: likewise with Babcock & Brown.

Macquarie Bank is writing down the value of investment in listed assets, but dividend and earnings are still occurring. Yes, those are at lower levels, but that is a function of the tougher business climate, not the write-downs.

In the case of ABC Learning where the entire asset side of the balance sheet was an act of fiction, earnings and dividends evaporated well before write-downs in goodwill and other intangibles started.

The real story the AFR should have been reporting on a year ago was the way asset values were overvalued in balance sheets, even if auditors were not saying that.

Australian companies have been slow to cut goodwill and other intangible values in the slump: American media companies like CBS and Time Warner have already lopped over $US40 billion from their balance sheet values alone.

Earnings were not impacted by that, but by slowing advertising revenues, subscriber income and profits from other areas of their operations. The write-downs should and have reflected the realisation that the profitability of these assets is going to be impaired by the economic slump.

News Corp remains the Australian company most exposed by the sheer size of its intangibles: around $US33 billion. A write-down similar to that at CBS (around $US14 billion or nearly half) would see News chop around $US16 billion from its asset values.

CBS, Time Warner and News Corp are all profitable, so the write-downs shouldn't impact operating earnings, income or dividends, except where the cuts reflect a drop in earnings, or an anticipated fall in coming months.

In fact the AFR's owner, Fairfax Media is a prime contender for huge write-downs, possibly of a billion or more because of falling revenues and profits from the broadsheet papers, the Sydney Morning Herald and the Melbourne Age.

On top of that there's the premium paid to acquire Rural Press. Fairfax has goodwill of $6.3 billion in its balance sheet as an asset. It would be highly optimistic to maintain that figure, given the 51% slump in newspaper classified (especially job) ads in the past year.

What the AFR is saying is that for the past decade Australian companies, like those in the US, UK and many other economies, have paid too much for assets that are no longer generating as much profit (or any profits).

In fact it's an action replay of the last few booms and busts and the same people who signed off the accounts in the good times as being 'fair and true' (with a string of get out clauses) are now going to say that the asset values are no longer valid and should be lowered.

Fairfax and News Corp are prime examples. The Seven Network is another media group where a big play has gone bad: the acquisition of 22% of West Australian Newspapers was done at prices well above current levels.

With brokers last week forecasting five tough years for WAN because of the slump in the WA economy, Seven's interim profit statement will be watched closely to see if there is any move to write-down the WAN holding.

Rio Tinto will be forced to make large write-downs because of the Alcan takeover is no longer worth the $A44 billion paid for it in 2007.

Wesfarmers is perhaps the prime candidate after Rio for a big write-down simply to produce a more realistic value for the Coles Group acquisition.

In the good times, directors and managements, with advice from valuers, investment banks and other analysts, assigned high and rising values to these assets; in many cases to justify the high prices being paid for them, which in turn justified the huge fees and other payments, or bonuses and other payments if they were on boards or in senior management.

Now those values are no longer applicable, so will anyone suffer at the various companies and advisers?

Will the auditors and other advisers who okayed the high price, asset values, and their fees, return those fees now asset values are to be cut?

Will boards and managements return some of the bonuses and other payments generated by the deals which led to these higher values being assigned to the assets?

With the banking sector under pressure, keep a close eye on the level of intangibles and other goodwill Westpac puts into its accounts to justify the high price paid for St George; and wonder how long those values can be carried at these new levels before the slump in the economy forces some cuts.

Not on your nelly, and that is the real, unstated story from the AFR's Page One story.

In the good times, everyone has their snouts in the trough, in the bad times no one is taking the blame. Shareholders, as usual, will bear the cost. But shareholders did like the high share prices these deals brought….

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