Reasons for writedowns on intangible assets

[adventurer]

Hello,

 

KraftHeinz is a recent example of a huge writedown on its brands Kraft and Oscar Mayer. How do these huge writedowns come about and what are the motivations? Because measuring values of intangible assets is not easy after all since I am not aware of a unified method in coming up with a value for an intangible asset. And if that is the case, how does one do the complete opposite (writing an intangible asset down)?

 

In Ben Grahams books readers were referred to always trying to find the fairest value of an intangible asset (or an asset at all). So the conclusion was to not completely write down intangible assets as well as to not overstate them but grant them a fair value. However I do not remember the exact method as to how (got to reread that  ;D).

 

Any Ideas?

[John Hjorth]

adventurer,

 

You'll need to study IAS 36 and its application for various industries to get the basic understanding of this accounting phenomen.

[gfp]

They come about through mergers and acquisitions primarily - Purchase accounting.  When you pay a control premium to acquire a business, you are usually "over-paying" - especially in this highly competitive environment.

 

You must assign the purchase price to the stuff you are acquiring and when you run out of real things to assign value to, you are left with intangibles:  goodwill, brand names, customer relationships, yada yada yada.

 

Since these intangibles are not amortized or depreciated regularly any more, they are "tested" periodically for impairment.  When the market and the world and the earnings and pricing power dynamics tell you that you can no longer justify $XXX for Oscar Mayer or whatever, you take a non-cash charge to adjust the carrying value to a slightly more defensible value.

 

Kraft was built through mergers and acquisitions and then the Heinz deal was consummated at a price that implied a pretty high value for Heinz (in terms of Kraft's share price).  Every deal creates purchase accounting fluff potentially.

[Read the Footnotes]

Yes to all of these comments.

 

 

When you pay a control premium to acquire a business, you are usually "over-paying" - especially in this highly competitive environment.

 

With respect to the previous comment, I will add a reference to the concept of "the winner's curse."

 

[LC]

KraftHeinz is a recent example of a huge writedown on its brands Kraft and Oscar Mayer. How do these huge writedowns come about and what are the motivations? Because measuring values of intangible assets is not easy after all since I am not aware of a unified method in coming up with a value for an intangible asset. And if that is the case, how does one do the complete opposite (writing an intangible asset down)?

 

As John mentioned there are accounting rules which require the evaluation of assets on a quarterly basis to determine whether the asset is impaired:

 

At the end of each reporting period, an entity is required to assess whether there is any indication that an asset may be impaired (i.e. its carrying amount may be higher than its recoverable amount). IAS 36 has a list of external and internal indicators of impairment. If there is an indication that an asset may be impaired, then the asset's recoverable amount must be calculated

 

That is all good and well: but let's be real. Did Kraft/Oscar Meyer lose all this value between Q4 2018 and Q1 2019? Of course not - value deteriorates over time.

 

What really happens is that, over time, value drops. But there are some conflicting forces at play: management obviously doesn't want to write down those assets slowly every quarter, and it is hard for external auditors to prove permanent impairment.

 

So what happens (at least in my experience) is that over time the value drops...drops....drops...until management cannot deny or justify to the auditors the current carrying value. Then they take a big hit, like what happened with KHC.

 

Just my 2 cents.

[Packer16]

Some additional insights here.  The control premium can be real if you have quantifiable cost synergies that can be realized.  This is true in some business like broadcast TV & folks like Tom Murphy were able to realizes these synergies.  In term of intangibles, all of them are amortized except FCC licenses, goodwill & IPR&D.  These are tested annually for impairment.  The models used to value intangibles are DCFs based upon projections provided by management that are tested by both a third-party appraiser (what I do) & the firm's auditor.  For brands, a relief from royalty method is typically used.  There are two main drivers for this approach projected revenue & royalty rate.  The royalty rate is based upon third-party transaction and the profitability of the product that the name is associated with.  The analysis also includes reconciling market data, reporting unit valuation & the value of the intangible.

 

A trigger for impairment includes not meeting expected budget or a decline in the firm's stock price.  Once the trigger is triggered, the impairment analysis is preformed.  If you have further questions let me know.

 

Packer

[LC]

Thanks Keith. Some additional information on intangible asset valuation for those interested:

 

https://www.oecd.org/tax/transfer-pricing/47426115.pdf