Tata Steel: Goodwill write-offs are confusing. When they happen, the managers of firms insist they do not matter. The simple, cynical—and largely true—view is that managers are vain and hate to admit mistakes

Tata Steel

Goodwill Hunting

May 14th 2013, 11:38 by P.F. | MUMBAI

GOODWILL write-offs are confusing. When they happen, the managers of firms insist they do not matter. Goodwill is the excess paid for an asset over its book value. Writing it down is a mere accounting adjustment, bosses tend to say. Yet those same bosses go to inordinate lengths to delay recognising such supposedly irrelevant, non-cash losses. On May 13th Tata Steel, an Indian firm, announced a $1.6 billion impairment, mainly of its $13 billion takeover of Corus, a British steelmaker. The deal happened six years ago. It has been clear for at least four years that it has been a financial disaster. Why recognise that now?

The simple, cynical—and largely true—view is that managers are vain and hate to admit mistakes. Investors usually decide an acquisition has gone bad within a year or two. The buyers’ shares drop. It takes longer for the accounts to catch up. Auditors should subject balance sheets to a yearly impairment test, but valuations are subjective and executives can twist their arms. When the auditors do, finally, assert themselves, companies are often blasé. An example is ArcelorMittal, another steel firm, which disclosed a $4.3 billion write-down in December. There has been no post-mortem of the long and value-destructive acquisition spree that helped generate it.The typical lag between error and admission seems to be about five years. Take the top 3,000 firms listed worldwide. In the boom of 2004-2007, takeovers were at a peak, and write-offs were minimal at about $30 billion a year. Impairments surged to $150 billion in 2012 according to Bloomberg data. If one ignores 2008, when banks were forced to clean up their books as they were bailed out, the previous impairment peak was in 2003, when the victims of the dotcom bubble, such as Time Warner, at last admitted reality.

Yet tardiness does not mean that goodwill impairments are meaningless. In fact, they can reveal a lot about the internal politics of firms and battles over strategy. Hewlett Packard’s (HP) $18 billion write-off in 2012 was a repudiation of a decade of mistakes, including the 2011 takeover of Autonomy, a software firm, but also of Compaq, a rival hardware maker, way back in 2002. Rio Tinto, a mining giant, booked a $14 billion write-down in January, mainly of its acquired aluminium business. At the same time its “deeply disappointed” chairman removed the chief executive, Tom Albanese. His successor wants to take a more cautious approach.

So what does Tata’s write-down signify? Ratan Tata, the patriarch of the Tata group, retired as chairman of Tata Steel on December 28th. Until he left, it was probably impossible to recognise that his biggest deal was a flop. His successor Cyrus Mistry has several underperforming businesses to deal with as we explained in our cover story at the end of last year.

Yet Mr Mistry has opted for a small write-off, most analysts think. Corus, they estimate, is worth a third or less of the $13 billion Tata paid for it, meaning the impairment should be many times bigger. So this is no cathartic moment, of the kind that HP and Rio sought. Instead of admitting total defeat, Mr Mistry probably hopes to sell all or part of Corus, or allow it to partially default on its huge debts (which are ring-fenced and not guaranteed by the Tata group).

Too big a write-off might suggest he would accept a pathetically low price, or cede control of Corus to the banks. Tata’s goodwill charge, then, tells you that the firm is not yet ready to walk away from its European arm. Given that this arm is losing about a billion dollars a year of free cash flow, that could be an expensive decision.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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