Goodwill Hunting

For companies mulling write-offs, economic turmoil is a terrible thing to waste.

One key to minimizing the damage is to communicate regularly with investors. “You will not see material reaction in the stock price if management has been disclosing realignment,” says Larry Levine, director of corporate finance and business-valuation services at McGladrey Pullen. “In an efficient market you would not expect the price to move, or movement would be de minimis at most.”

In fact, write-offs can be perceived as a form of good news, says management consultant Eric Olsen of Boston Consulting Group. They may eject obsolete inventory, bad receivables, or other baggage that investors know about and the market price reflects. “Take that write-off,” says Olsen. “It’s good news because you are not surprising the Street. You’re saying to shareholders, ‘We’re with you; we’ll address this issue now.’” Conversely, Olsen says, write-offs can also be perceived as totally unexpected bad news, as when they reveal that working capital is not under control.

While shareholders may react favorably based on their perception of future prosperity, lenders react to write-offs in a different way. They wield legal contracts that impose penalties if goodwill write-offs violate asset-based covenants. “When a real loss is written on the balance sheet,” says the University of Chicago’s Ball, “lenders can enforce their contractual rights.” Write-offs alert lenders that loans are skating on thinner ice and may risk a technical default or a harsh change in terms.

Mohawk’s recent write-off shrank total 2007 assets by 16 percent, but CFO Boykin knew his credit line was safe. “Our debt-to-capitalization ratio stays below 60 percent,” says Boykin. “Even with the write-off we had plenty of room. But you must take a look at that early in the process.”

Like them or not, as a response to a besieged stock price, goodwill write-offs promote penance and renewal. They own up to past mistakes, repair balance sheets, and help restore investor confidence. As corporate decisions go, to err is human, to take a goodwill write-off is sublime.

S.L. Mintz is a deputy editor of CFO.

When Write-Offs Go Wrong

While goodwill write-offs have many virtues, don’t assume they will generate tax benefits. Sprint reported that the “substantial majority” of its giant write-off produced no tax benefit at all.

Benefits accrue only when a transaction that produced goodwill was set up initially as a taxable purchase of the target’s assets, a rare occurrence. Undertaken with unbridled optimism, like most mergers, Sprint’s merger with Nextel was never structured to produce tax benefits if it failed. “The goodwill impairment charge,” says corporate tax expert Robert Willens, “had the effect of penalizing Sprint’s net income and shareholders’ equity without an accompanying tax benefit: the worst of all worlds.”

Even when recording impairment of tangible or intangible assets, write-offs can be tricky. “There is no automatic deduction,” warns corporate tax accountant Paul Beecy at Grant Thornton. Deductions ordinarily occur when an asset becomes worthless and means absolutely zero. In that case, Beecy advises, get rid of it to forestall any doubt about your conviction. There may be some opportunities for partial worthlessness, but they don’t apply just because a viable customer is short of cash and does not want to pay. “Unless you dispose of the asset,” says Beecy, “you are facing an uphill battle.” — S.L.M.

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