German businesses are contorting their balance sheets as never before. Expensive takeovers have left the 30 companies of the Dax, Germany’s most important stock market index, carrying almost €300 billion ($342 billion) in what is known as “goodwill,” a vague and intangible asset.
In an economic downturn – something many are now predicting – this figure could be a multi-billion-euro bombshell for some firms. If newly bought subsidiaries see a serious collapse in business, “goodwill” values have to be radically revised, which could translate as large losses on the bottom line.
Several companies are in deep: Bayer’s takeover of Monsanto, for example, racked up a remarkable €23 billion in goodwill. Thyssen-Krupp has already been burned: its acquisition of American steelworks shrank its equity to just €3.4 billion, after a goodwill write-down of €3.8 billion. Numerous takeovers have left Healthcare company Fresenius with a goodwill figure higher than its overall equity.
“If the economy dips and demand tails off, as they did in the third quarter, a lot of German companies could see write-downs, and then losses,” says Kai Lehmann, an accounting expert at asset manager Flossbach von Storch. Several companies, including Deutsche Post, BMW, Daimler and Continental, have issued profit warnings in recent months.
Relying on faith
If one company takes over another, the price is nearly always higher than the cumulative value of its tangible assets: its machines, vehicles, property, patents, order book, and so on. The remainder of the takeover price is something more intangible – faith in the workforce’s knowhow and a belief that its business model will stay strong.
That’s an absolutely legitimate asset: “goodwill” is a real and valuable thing, and has to be paid for. The trouble is that in recent years the total amount of goodwill has been spiraling upwards. That €297 billion – the total in the Dax 30 balance sheets – grew by €40 billion last year, and is now double what it was in 2005.
That year, 2005, was an important one in the history of goodwill in Germany, when a small but significant change in accounting regulations was imposed. Previously, companies making acquisitions had to amortize excess goodwill over the next ten years. After the requirement was abolished, companies largely stopped doing this.
This has left some companies “owning” large amounts of goodwill. Software giant SAP, for example, once relied almost entirely on organic growth. But in the last nine years, the company has bought over 20 companies, some at dubiously high prices. This is reflected in a much-inflated goodwill figure, which went from €627 million to 2005 to €23.5 billion in 2017.
When goodwill goes bad
Not all companies have played the goodwill game. BMW, Lufthansa, the personal products group Beiersdorf, and chemicals firm Covestro have almost none on their books, nor do Daimler, Deutsche Bank or reinsurer Munich Re.
If companies taken over continue to increase in value, there’s no real problem with goodwill. But if things turn sketchy – demand dwindles, product lines become unpopular – it can mean a bruising hit to the balance sheet.
This is by no means confined to Germany: last month, General Electric had to write down $23 billion dollars, reflecting a slump in the value of fossil fuel subsidiaries it bought some years ago. To add insult to injury, the loss meant it was booted off the Dow Jones Index, of which it was a founder member.
So who decides what goodwill is really worth? Companies generally bring in external auditors to conduct “impairment tests” on acquisitions, to see if they are still more or less worth their listed value. The trouble is that the entire process is opaque to investors, who only ever see the final value.
Small regulatory changes can have real-world consequences. The German Financial Reporting Enforcement Panel – not generally known for hotheaded exaggerations – recently warned that the 2005 rule change had encouraged executives to go for much riskier takeover strategies.
The biggest question mark now hangs over Bayer’s Monsanto takeover. The US agribiotech business ultimately cost the German firm around €55 billion, 44 percent higher than its market capitalization at the time of its initial bid.
Some €23 billion has since been categorized as goodwill, prompting Bayer to raise new capital. The company says its auditors “have always confirmed the intrinsic value of goodwill listed in our accounts.” No write-downs, in other words. But some in the market are more skeptical. But one Frankfurt trader told Handelsblatt: “Numbers don’t lie. Capital markets expect write-downs and losses from Bayer.”
One consolation for investors in Dax-listed companies: Wall Street has an even worse problem. Around 36 percent of the equity of the 30 Dax companies is goodwill. But the figure for the Dow Jones is around 50 percent.
Ulf Sommer reports for Handelsblatt on companies and financial markets. To contact the author: [email protected]