Sony Warns of $962 Million Goodwill Loss
Several things I don’t understand here. What is a goodwill or impairment loss? Or a non-cash loss? And shifts in the entertainment space I get but how on earth could a studio purchase 30 years ago impact on Sony now?
I admit that I’m out of my depth here. Can anyone help me to make sense of this?
Let’s say international conglomerate FooCo decides to acquire a widget factory to get in on that sweet sweet widget-manufacturing action. How much should they pay for the factory? One thing you can do is add up the value of all their assets: buildings, machines, inventory, delivery contracts, money owed to them from customers, and so on. Then you subtract their liabilities: debts, payroll, money they owe to suppliers, etc. Let’s say all that adds up to $10 million.
The factory owners will probably not sell it to you for $10 million, however. For one thing, they know you’re going to earn profit from the factory as long as it produces and sells widgets, and that’s worth something. For another, they know that you really want to get in the widget game, and they have a widget factory, and that means they can sell at a premium. They also know that their factory has a reputation as the best widget maker, and FooCo will be acquiring that as well. All of these “intangible” assets, which can’t really be accounted in any reasonable way, constitute “goodwill.”
So if FooCo buys the factory for $12 million, they can account for the acquisition as a factory worth $10 million plus $2 million in “goodwill.”
Goodwill is required to be accounted for separately from tangible assets, so that people reading the books understand what is actually being accounted for in things that can be valued and added up vs. the far more nebulous concept of goodwill.
Years later, the market for widgets crashes, and nobody is interested in buying them anymore. The factory sells fewer and fewer widgets and earns less and less profit for FooCo. The fact that the factory is now earning substantially less money than in the past means that the premium that FooCo paid - the extra $2 million - is now too high. Another way to look at is: if FooCo were to sell the factory now (assuming all its tangible assets were worth the same, which they wouldn’t be, but ignore that) they would not get $12 million for it, and might not even get $10 million.
That difference in value is a goodwill impairment, basically an acknowledgement that you would not be able to get that much of a premium over tangible assets if you sold the thing. (There are many other things that can decrease the value of an asset, goodwill impairment is just one. In real life, the factory machines and buildings would also depreciate as they got older.)
So, Sony:
In 1989, in a series of transactions, Sony acquired Columbia Pictures and related assets, which after a series of reorganizations and other acquisitions, eventually became part of the massive Sony Pictures Entertainment, an American subsidiary of Sony.
Sony paid a large premium over the book value of Columbia’s tangible assets, and recorded several billion dollars of goodwill for Columbia Pictures on their balance sheets.
One of the most profitable arms of the SPE subsidiary had been their home video sales, but the market for home video (sales and rental) has imploded in recent years. Because that part of the business is earning substantially less money, Sony has to record a goodwill impairment of $962 million to show investors that the intangible assets SPE (cash flow from future home video sales, plus other stuff, I assume) are now not worth as much.
“Goodwill” is just the value of a company above the value of its assets. So if you buy a company that has $100 million with of “stuff” for $150 million, there is $50 million worth of “goodwill” in there.
A goodwill loss is an acknowledgement that the value of a company is no longer what it once was, even though it hasn’t lost anything tangible (like a factory burning down or something).
“Impairment” is a situation where the book value of an asset (even an intangible one like goodwill) is larger than the currently expected fair value.
It’s all basically a bookkeeping way of saying, “this stuff we bought isn’t actually as valuable as we thought it would be when we bought it”.
The short version is that when one company acquires (buys) another one, they typically pay more than the sum of the company’s assets. The acquiring company usually expects to be able to increase revenue or decrease costs in the acquired company, and get additional value of it that way.
Under strict accounting rules, acquiring an asset for more than it’s worth would lead to an immediate loss on the transaction. So after a company is acquired, the acquiring is allowed to add a non-tangible asset called “goodwill” to their balance sheet equal to the additional amount of money that they spent. This effectively represents the additional profits that they expect to make from the company. If the acquisition goes as planned, then the additional profits from the new division should offset the goodwill over time.
If the acquisition goes poorly, then the acquirer eventually has to admit that the acquisition was a failure and officially take an accounting loss on the transaction. That’s what has happened to Sony here. They bought a movie studio for $912M more than it was worth, and now they’ve had to finally fess up that they screwed up and the additional profits that they planned on are never arriving, meaning that “goodwill” asset that they acquired doesn’t exist. When an asset is removed from the balance sheet, that means (in accounting terms) the company has taken a large expense. The $912M is such a large expense that it caused them to be in a net loss position for the quarter.
They’re calling it a non-cash loss because the loss didn’t cost Sony any money. The money was spent 30 years ago, but Sony has only just now gotten around to admitting that they didn’t get value for their money.
Heck, I’m gonna put myself down for an impairment loss of $1M on my taxes this year! My accountant is gonna love this!
I will nitpick just a bit to point out that the write-down doesn’t necessarily mean that Sony screwed up or failed; indeed their acquisition of Columbia has been enormously profitable over the past 30 years.
But business environments always change, and even the most brilliant people at Sony would be hard-pressed to predict what would happen to home video today in 1989.
Impairment writedowns are perfectly common and not necessarily a big deal; this one is prominent because the number is big and Sony is a huge publicly-traded company.
As Rysto points out, Sony didn’t lose any actual cash, they’re just saying that the intangible assets of SPE are now worth less money than when they bought it.
My understanding is that expenses related to impairment of goodwill aren’t deductible, though the regular amortization of the goodwill is deductible which would create a temporary book/tax difference.
Amortization of goodwill is no longer allowed, AIUI.
Goodwill is amortizable for tax purposes over 15 years in the US; IRC Sec 197. It has not been amortizable for financial reporting purposes according to US GAAP for as long as I’ve studied accounting (which is only a few years though).
Treatment in other countries may differ.
Historically under US GAAP for financial reporting Goodwill was able to be amortized over 40 years. This changed in 2001 in part due to tech sector acquisitions generating large amounts of goodwill and the mandatory amortization expense weighing down the P&L. The FASB was persuaded and voila, no more amortization of goodwill - instead it was replaced with impairment analysis.
Goodwill is also available to be amortized for financial reporting for privately held companies straightline over 10 years since ASU 2014-02.
Did you pay $1M for goodwill when you bought yourself? If not, there may be a major difficulty with your plan. Well, there maybe more than one major difficulty, actually.
When I acquired myself, at birth, I had, I was assured, limitless potential. Every year I fail to live up my potential, I am surely incurring a goodwill or impairment loss, as my potential and available time to achieve that potential eases somewhat. Seriously, my accountant if gonna love this!
You know infinity minus $1M is still infinity, right?
What has been suggested facetiously here a few times already, was this not an enormous scandal, of an Enron-type magnitude–following an accounting principle where future profit was estimated by pulling huge numbers out of their ass, then receiving something tasty in return? I’m not sure what, either a write-off when those numbers weren’t met, or some incredible valuation or credit line based on them?
You could describe “goodwill” as the intangibles such as reputation, historical expectations, etc… that make a company’s value higher than the strict value of its assets.
Tech companies tend to have huge goodwill values relative to more traditional businesses, because they tend to have very low asset values for plant, property and equipment. I mean, look at Apple- they don’t own factories, and maybe have a handful of buildings, servers, etc… but their actual valuation is colossal, and probably many times what the physical assets would indicate. Conversely, Ford or GM’s valuation probably contains a huge proportion of manufacturing plants, etc…
So long as they didn’t lie in their accounting, about how much “non tangible” value there was in the transaction, no. Goodwill, even large amounts of goodwill, is a legitimate concept in accounting in these transactions, and simply being wrong about how much an acquisition is worth is not a crime.
You can say that Sony should have known that SPE was not worth as much as they paid for it 30 years ago, but that is not an accounting scandal. They just made a big bet, and were wrong.
This is my favorite thing I’ve read today. Good job.
To be perfectly clear: Sony did not do anything wrong here, and nobody is accusing them of having done anything wrong.
They did not pull numbers out of their ass. It is not reasonable to expect an acquiring company to predict the nature of a consumer market 30 years into the future.
They paid a premium to acquire and assemble SPE, and it worked out very well for them. The movie business is still very profitable if you can churn out hits.
Every year, Sony is required to evaluate all the goodwill holdings on their books. The way they do that is to calculate a net present value for the underlying asset. That basically means, “how much is the potential future income stream from this asset worth today?”
To put that in perspective, say I make you an offer: you give me $15 today and I’ll pay you back $20 tomorrow. Pretty good, right? Now here’s another offer: you give me $15 today and I’ll pay you back $20 on April 1, 2096. Not so good. Even though the net profit is the same (five bucks) the increased waiting period makes the latter offer shitty. So its present value - the amount the offer is worth right now, is substantially less.
This year, Sony looked at its potential future income from home video sales to calculate the NPV of their home video income stream over the next year. When it turned out that the NPV fell below the goodwill value on their books, they were required to record a goodwill impairment. All the impairment does is say to people: this home video business that we acquired is no longer generating as much income as it was, and the NPV of that income is less than the premium we paid for the business a few decades ago.
The impairment does not mean that they screwed up their accounting, or deliberately misled anyone, or that they acquired a failing business. They are simply stating that their home video business will not generate very much future revenue.
Oh yes, I understand the principle when it is done correctly, and am not claiming anything different for Sony.
As a language note, “goodwill” strikes me as a fundamental rejection of all Marxist and some Christian understandings of economic life.
Agree completely with freido just above.
Having said that, there is a lot of room for management discretion in those legit calculations and their timing. After all, they are making an updated prediction about the future which the sage Yogi Berra has said is especially hard.
There are lots of ways for goodwill impairment to be gamed as to both size and timing. Management can bump it up in especially profitable years and soft-pedal it in slower years to smooth total earnings over the longer term. Or vice versa if they have a reason to make a bigger splash one way or another right now.
I’m not familiar enough with the specifics of Sony in 4Q2016 to know how much or little gamesmanship is in the write-down.
ETA: @Leo: What was named “goodwill” a hundred-plus years ago would be called “brand equity” today. It’s the idea that of two identical soap factories, the one making Tide will enjoy better profitability than the one named “LSLGuy’s WonderSoap.” Because the customers think highly of one brand and don’t think at all of the other. The business’s good works over time creating satisfied customers will bring future value.
All this dates from an era when accountants were viewed more as impartial referees and scorekeepers of business rather than head cheerleaders & aggressive loophole exploiters.