Saturday, 12 November 2011

CSC’s $2.7billion Goodwill impairment charge – why it matters.

CSC wrote off almost $2.7billion of goodwill in Q2 FY12.   
Here is CEO Mike Laphen’s explanation at the November 9 earnings call:

“We have taken a noncash goodwill impairment charge (….). In our estimation, a key contributor to this charge is the fact that our stock price, which has been under pressure from both market declines and the uncertainties surrounding the MSS challenges, depending CSC investigation, the NHS program and U.S. federal budget deficits. Although we expect these uncertainties eventually to be resolved, our low stock price has persisted for a sufficient period to create a discontinuity between market price and the book value. And it is this discontinuity that necessitates the adjustment to goodwill”.

This  explanation focuses on the financial approach, as if the charge is driven by unavoidable accounting requirements and market factors outside CSC’s control . It does not explain what the impairment charge means in a business layman’s terms.  Here is another way of looking at it:

Over the years, CSC has acquired a number of businesses whose goodwill values  (*) totalled $4.5 billion , which is broadly what CSC  paid for them.  CSC’s management of these acquired businesses has reduced the goodwill values to some $1.8billion based on the company’s  best assessment of the situation today.   CSC hopes to improve this situation in the future , but for now it is obliged to write off the $2.7billion goodwill value it has destroyed.

Management’s poor performance has driven CSC’s share price to the point where the market value of the goodwill of CSC in total stands at $3.4billion (**) today. Continuing to value goodwill of just one part of CSC (ie those businesses which came to the company via acquisition) at $4.5billion would be absurd. Thus the need for a $2.7billion impairment charge to reduce goodwill relating to acquired businesses to a more realistic $1.8billion.

 (*) Goodwill can be defined as the underlying value of the intangible assets of a business, including their capabilities, know-how, intellectual property,  employee skills, client base, future earnings potential etc  
(**) Being CSC market capitalization less its net tangible assets

posted by Littlejohn

1 comment:

Anonymous said...

This is a very interesting development as it also means that it should be possible to sell off businesses that are not performing without having to take a goodwill write-off at the point of sale, making the numbers impossible.