Wednesday, 30 March 2011

CSC/iSoft - How the accounting for this deal could get CSC out of an earnings hole this fiscal year .........and next

According to an article in "The Australian" CSC could buy iSoft for $300million this week.

"Dream ends for iSoft with $300m buyout | The Australian"

CSC will move heaven and earth to get this deal completed before its fiscal year ends on Saturday April, 2, as it could solve their problems regarding the earnings of this quarter and of future quarters.

Here's why:

CSC is in trouble with the NHS program. As reported by Cassandra on March 27, they missed a significant milestone this month, which must impact its profits. It is a fair assumption that one of the reasons CSC dropped its earnings forecast for this quarter in February was the expectation of more problems and costs with NHS.

But if they buy iSoft, CSC can deem that these NHS problems are due to iSoft and its software product, not due to CSC shortcomings. So on acquiring iSoft, look out for CSC putting a big provision in iSoft's accounts for present and future losses on the NHS project. How big will the provision be? As big as the auditors will allow. But by accounting for the costs and losses in this way, it does not touch CSC's profit at all. Magic isn't it? Instead, it increases CSC's "goodwill", which is an intangible asset on the balance sheet representing the difference between the net book value of iSoft's assets at the time of acquisitionb by CSC and what CSC paid for iSoft. And by putting in more and more provisions for future losses, you reduce the value of iSoft's net assets, thus you increase CSC's "goodwill" , and reduce the amount which will be charged against CSC's profits. Intangible assets, of course, are ....well.....intangible..Meaning you can't touch them or move them. Like beauty, they only exist in the eye of the beholder. And it certainly does not mean iSoft is worth more.

Everyone will be happy with this piece of accounting magic. It will make no difference to the price the iSoft shareholders receive from CSC. It will make no difference to their joint customer, NHS, who will remain just as unhappy as before. It will make no difference to the overall NHS project which will remain a mess. But it could increase CSC's profit significantly, just by keeping costs out of the Profit and loss account and putting them on the balance sheet as an intangible asset instead...which is what CSC tried to do in Nordics 12 months ago. So Mr Laphen will be able to tell shareholders and market analysts how he has managed to improve the company's profitability.

So if it acquires iSoft, look carefully at CSC's goodwill account when they publish their year-end financial statements. One stroke of an accountant's pen could make more difference to CSC's profit than all the work and value-added by all the work done for customers in many of its businesses. But while this accounting magic may change the reported profit, it will not change the dismal reality of the business situation at all.

Posted by Littlejohn,

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