Just how big does an acquisition-related charge have to be before anybody sits up and takes some notice? A billion dollars? Two billion? Try five billion dollars on for size. Compaq Computer Corp has just stuffed its second quarter with $5.16bn worth of charges, all of which have been attributed in one way or another […]
Just how big does an acquisition-related charge have to be before anybody sits up and takes some notice? A billion dollars? Two billion? Try five billion dollars on for size. Compaq Computer Corp has just stuffed its second quarter with $5.16bn worth of charges, all of which have been attributed in one way or another to the acquisition of Digital Equipment Corp. The DEC deal cost Compaq and its shareholders around $9bn all told, and although the company has just put through a combination of charges and provisions which total more than half of this value, taking the giant computer maker into net losses of $3.6bn, nobody seems to give a damn. Compaq operating earnings just beat analysts’ expectations said Yahoo! Finance. Followed by, It’s pretty much business as usual, from Lou Mazzuchelli, a PC analyst at Gerard Klauer Mattison, quoted by Reuters. A company makes charges which are roughly comparable in size to its entire revenues in the quarter, with the indisputable effect of boosting future earnings, and the financial community just looks the other way. Which virtually guarantees that next time around, the company concerned will make the charges even bigger. The lion’s share of Compaq’s most recent charges stem from a $3.2bn write off of ‘Purchased in-process technology’. The purpose of this being to negate the creation of purchased goodwill and to reduce the balance sheet value of other assets acquired in the deal. In so doing, Compaq reduces the effects of amortization charges on future earnings, and reduces the group’s total net asset value to boot. Hence, the two most crucial financial performance indicators, namely earnings per share and return on capital employed, are both given a useful leg up. On top of this, we have a $291m charge for Compaq staff lay-offs and facility closures and a further $139m for other operating adjustments. Next to the R&D write-offs, these charges go almost unnoticed. But if just 10% of this ‘one-off’ balance was deemed to be part of Compaq’s ongoing business costs, the claimed net income for the quarter of $32m before charges would suddenly transform into an operating loss. And yet we are given no information, not even an auditor’s opinion, as to why these costs relate to the acquisition of DEC and not Compaq’s ongoing business operations. Combining the above figures, we arrive at the headline total of charges in the quarter reported by Compaq of $3.66bn. So where does the $5.16bn come from? Well, it seems that Compaq has resorted to the use of pre-acquisition write downs to account for this deal, a technique so widely abused by companies in the UK that the practice was completely banned. In this instance, just before the two companies assets are combined into one entity, DEC has been forced to make a $1.5bn provision for the costs of laying off its own employees. The entire provision then transfers onto Compaq’s balance sheet without ever touching consolidated earnings. The reason the practice gained such a bad reputation in the UK was because the acquiring company would deliberately over state the size of the provision made for reorganization costs, allowing an invisible boost to consolidated earnings when the unused portion was reversed back through the profit and loss account at a later date. Not to say that this is what Compaq will do, but the technique has been used before with the sole intention of making an acquisition appear more profitable than it actually was. All in all, Compaq has used every available trick in the book to account for its purchase of DEC. And the sad fact of the matter is that every single one is legitimate under US GAAP (Generally Accepted Accounting Principles). And because these kinds of charges are difficult to predict and equally difficult to break down, financial analysts persist in their practice of totally ignoring them. So before you pile your hard earned savings into Compaq’s stock, based on the premise that it’s trading at 20 times next year’s earnings, you might like to consider what this 20 times figure is based upon. Because the ‘consensus of analyst’s estimates’ for the future earnings of an acquisitive company like Compaq takes no account whatsoever of the accounting methods outlined above. And the disquieting fact remains that while the bull run in US equity markets continues to push stocks to all time highs, nobody really seems to care. Compaq refused to allow ComputerWire to participate in the conference call to analysts announcing second quarter earnings. The company also declined to respond to our request for further information about the $1.5bn charge made by DEC prior to its consolidation into Compaq.