How much is your goodwill worth?

Transcription

1 How much is your goodwill worth? Purchase price allocation and goodwill impairment in Swiss practice July 2011

2 Contents Purpose and approach of investigation 3 Key findings 4 Purchase price allocation in practice 5 Manufacturing industry Financial service providers Life sciences and health care Technology, telecommunications and media Retail and consumer goods Energy and utilities Summary Goodwill impairment testing in practice 13 Goodwill and balance sheet total Goodwill and equity Intangible assets and balance sheet total Intangible assets and equity Size and frequency of goodwill write-downs Contacts and authors 19 2

3 Purpose and approach of investigation This study analyses financial reporting in connection with corporate mergers and amortisation of intangible assets, especially goodwill. Its main focus is on evaluation and analysis of purchase price allocation (PPA) in various industries, and on goodwill impairment testing in Switzerland. The study findings should provide a tool for decision-makers in companies which compile accounts according to IFRS. It will help them to estimate the following factors in a planned transaction, based on guide quantities for their industry: Amount of intangible assets/goodwill Effects of amortisation of intangible assets on the profit and loss account The study also considers whether it is correct to expect goodwill write-downs, in the context of impairment testing practice at Swiss companies, to turn out much higher at times of recession (e.g ) than in years of strong economic performance (e.g ). The study relies both on analysis of 62 PPAs over the period and on an evaluation of information on intangible assets/goodwill and impairment testing. The latter information derives from the annual reporting of 151 listed SPI companies, as per IFRS, for financial years We hope you find the study interesting and exciting. At the same time, the study may support the plausible presentation and classification of final PPA findings, in a cross-cutting comparison with other transactions in the same industry. Markus Bucher Head of Advisory Partner Martin Schilling Valuation Services Director 3

4 Key findings Purchase price allocation Goodwill impairment testing In strong growth industries, goodwill accounts for more than 5 of purchase price. Despite the economic and financial crisis, many companies still consider goodwill items to have intrinsic value. As a proportion of total merger costs, goodwill accounts for around 42%. Its actual amount varies considerably, depending on the individual expectations of growth and synergy saw a rise in the number of companies showing amortisation of goodwill and in the level of value adjustments applied, compared with the low levels of previous years. The figures remained high in Different sectors attribute different importance to Intangible assets (client relationships, brands or technologies). In most sectors, goodwill averages more than 2 of equity. In the PPAs examined, identified intangible assets, shown separately from goodwill, amounted to an average of 39%, ranging from 1 to 6 of total purchase price, depending on the transaction. Companies in the technology, telecommunications and media, as well as retail and consumer goods sectors show the highest proportion of goodwill, at 3. 4

5 Purchase price allocation in practice Source industries of examined transactions (absolute and %) A PPA is the process whereby the purchase price paid for the acquired company is allocated to the acquired fixed assets and liabilities. 9 (15%) 5 (8%) 7 (11%) 19 (31%) The following sector-by-sector analysis examines how the purchase price is spread in practice between the identified intangible assets and goodwill. To guarantee maximum transparency in this regard, the identified intangibles are subdivided into the categories of client relationships, brands, technology and other assets. The pie chart on the left shows the source industries of the 62 transactions (PPAs) examined during our analysis of the period The composition is a clear reflection of Swiss business, with a clear overweighting in the fields of manufacturing industry and financial services. 7 (11%) 15 (24%) Industrial manufacturing Financial services Life sciences and health care Technology, telecommunications and media Retail and consumer Energy and utility 5

6 Manufacturing industry Purchase price allocation in practice Composition of purchase price (%) Goodwill averages 36% of purchase price % Composition of identified intangible assets (%) 15% Purchase Price 4% 49.8% Net Assets Intangibles Deferred Taxes (13.7% ) 36.2% Goodwill Goodwill, as a proportion of purchase price, tends to turn out lower than in other industries, at 36%. The reason is that, when transactions are to take place in traditional industries, future growth potential tends to be estimated on the low side. Besides, the value of identified intangible assets (5) is higher than in other industries, as these are mostly established firms with long-term customer bases. Our experience of transactions shows that client relationships account for 54%, and the brand for 27%, of the total value of identified intangible assets. These are not only assigned considerable importance, but are estimated as having a relatively long residual life, of 13 years on average. The key drivers of value in client relationships are contractual relations along the supply chain and order books. As for brands, particular drivers of value are product and corporate brands. In the case of transactions, cross-europe comparisons show that intangible assets (including goodwill) account for a similar overall proportion of transaction volume. However, in Switzerland, a clearly higher percentage is allocated to identified intangible assets (especially client relationships). As interviews with industry representatives show, this is because higher margins tend to be achievable in Switzerland. 54% 27% Client relationships Brand Technology Others 6

7 Financial service providers Purchase price allocation in practice Composition of purchase price (%) % 77% of intangible assets are attributable to client relationships Purchase Price Composition of identified intangible assets (%) 6% 13% 38. Net Assets Intangibles Deferred Taxes (10.4% ) 41.1% Goodwill In the examined acquisitions of Swiss financial service providers, an average 38% of the purchase prices were attributed to intangible assets and 41% to goodwill. However, there are considerable differences between transactions. In the alternative asset management field, for example, the percentage of goodwill is more than 6 and therefore higher than in traditional retail and private banking. Two reasons account for this: firstly, alternative asset managers rarely have substantial tangible assets and also tend to have a relatively low equity base; and secondly, most of these transactions took place in the years , when estimates of growth potential had been optimistic. In the financial sector, client relationships assume above-average importance, at 77%. This can be explained by the long-term nature of these client relationships. In the PPAs analysed, a residual useful economic life of 15 years was most commonly assumed. Thus another factor in the high value of client relationships is that high margins have hitherto been achievable in Swiss banking. Therefore, in all-europe transactions, the lower profitability of client relationships results in a smaller intangible assets element in purchase price, and a larger goodwill element, than in Swiss transactions. 4% 77% Client relationships Brand Technology Others 7

8 Life sciences and health care Purchase price allocation in practice Composition of purchase price (%) % Purchase Price Composition of identified intangible assets (%) 1% 33. Net Assets Intangibles Deferred Taxes (9.1%) 55.5% Goodwill Purchase price contains an average 56% goodwill element. At 56%, goodwill accounts for a more significant portion of total purchase price in the life sciences and health care sector, though sometimes wide fluctuations are observed within subsectors (pharmaceuticals/generic medicines, biotechnology and medical equipment). The large goodwill element reflects the industry s above-average growth potential, which leads to correspondingly high purchase prices being paid for acquired companies. Around one-third (33%) of purchase price is attributable to intangible assets. Our analysis shows that client relationships (44%) and acquired technologies (43%) are significant elements of the total value of identified intangible assets. With lifetimes averaging 15 years, even rising to 25 years in individual cases, these are the longest in our cross-cutting comparison. Often, this is attributable to long-term patent protection. In the client relationships, long-term purchasing, cooperation, sales and licensing agreements stand out. By contrast, in the technology sector, research and development projects, and patented and (as yet) unpatented technologies are mainly noted. Interviews with industry representatives, and our experience from transactions, show similar values to Switzerland in the cross-europe comparison. 43% 44% 12% Client relationships Brand Technology Others 8

9 Technology, telecommunications and media Purchase price allocation in practice Composition of purchase price (%) % An average 54% of purchase price attributable to goodwill Purchase Price Composition of identified intangible assets (%) 13% 6% 28.7% Net Assets Intangibles Deferred Taxes (7.9% ) 53.7% Goodwill At over 5, goodwill is a significant factor in technology, telecommunications and media firms. This shows that future growth expectations are very important in this sector. On the other hand, intangible assets account on average for just 29% of purchase price. Analysis of identified intangible assets also highlights the great importance attributed to client relationships (71%). In the telecommunications and media sectors, these consist, especially, of subscribers and advertising clients whereas, in the technology sector, they tend to derive from supply and cooperation agreements. As for residual useful life of client relationships, we find a very broad span of time, ranging from 2 to 15 years. These large differences are explained as being due to the differing origins of client relationships. It is striking that technology accounts for only a small proportion of intangible assets of companies in the telecommunications and media sectors. The picture is different, in this regard, in the technology companies. Here, not only client-related assets, but also technology itself, as an asset item, are of central importance. 1 71% Client relationships Brand Technology Others 9

10 Retail and consumer goods Purchase price allocation in practice Composition of purchase price (%) % Purchase Price Composition of identified intangible assets (%) 12% 50.3% Net Assets Intangibles Deferred Taxes (13.8% ) 43.2% Goodwill Client relationships and brands each account for 44% of intangible assets. In transactions in the retail and consumer goods sector, 43% of purchase price is attributable to goodwill, whereas over 5 of purchase price is attributable to intangible assets. 44% of intangible assets are attributable to client relationships, and a further 44% to the brand. The assumption tends to be that the former have a long lifetime, with an average of 15 years. This is due to the long-term nature of contracts of supply and licensing agreements. In the context of transactions, we also note franchising agreements in the retail trade while, for consumer goods, process technologies and formulae are further drivers of value. Compared with other sectors, brands (corporate and product brands) have higher than average significance. This is also reflected in the assumed residual lifetime in each case. In the majority of transactions examined, the assumption is that brand lifetime is indefinite. Transactions in the retail and consumer goods sector are often internationally driven, or shaped and influenced by cross-border price competition. Therefore, even in cross-border transactions, we note a similar proportion of goodwill and intangible assets in the total purchase price. 44% 44% Client relationships Brand Others 10

11 Energy and utilities Purchase price allocation in practice Composition of purchase price (%) Goodwill and intangible assets are less important % Purchase Price 34.9% Net Assets Intangibles Deferred Taxes (7.9%) 20.6% % Goodwill In the utility PPAs examined, around 52% of purchase price is attributed to net assets and hence predominantly to tangibles. Compared with other sectors, goodwill (21%) and intangible assets (35%) are only of secondary importance. The results illustrate that, for the examined companies in the infrastructure field, tangible fixed assets are the key drivers of value (mainly generation plants and grids). The identified intangible assets amount to around one-third of purchase price. The largest proportion of these (9) are contract based intangibles, consisting primarily of long-term contracts of procurement and of sale. Composition of identified intangible assets (%) 1 9 Contract based Others 11

12 Summary Purchase price allocation in practice Composition of purchase price (%) (13.7%) (10.4%) (9.1%) (7.9%) 36.2% 41.1% 55.5% 53.7% (13.8%) 43.2% (7.9%) 20.6% 34.9% Across all sectors, the proportion of goodwill as a percentage of purchase price ranges from 21% to 56%. The bandwidth of intangible assets as a portion of purchase price ranges from around 29% to 5. The proportion of net assets fluctuates between around 2 and 52% % % 31.4% % 28.7% 25.5% 50.3% 20.3% 52.4% Industrial manufacturing Financial services Life Sciences and health care Technology, telecommunications and media Retail and consumer Energy and utility Net Assets Intangibles Goodwill Deferred Taxes Composition of identified intangible assets (%) % 15% 27% 54% Industrial manufacturing Financial services 13% 6% 4% 77% 1% 43% 12% 44% Life Sciences and health care 6% 13% 1 71% Technology, telecommunications and media Contract based Brand Technology Others Retail and consumer 12% 1 44% 44% Energy and utility 9 As for the composition of identified intangible assets, most is usually attributable to client relationships or is contract-related. The percentage ranges from around 44% to 9. Depending on the sector, the remaining identified intangible assets are weighted as follows: brands 0 44%, technology 0 43% and others 1 13%. 12

13 Goodwill impairment testing in practice Industry classification of examined companies (absolute and %) In the context of the economic and financial crisis, the goodwill shown in the books has, once again, increasingly caught the eye of compilers and readers of balance sheets. 19 (13%) 6 (4%) 9 (6%) 5 (3%) 40 (26%) IAS 36 requires goodwill positions resulting from past transactions and intangible assets to be reviewed for impairment and to undergo an impairment test at least once a year. The purpose of impairment testing is to assess whether the book value of the goodwill is still realistic (recoverable). If it emerges that the book value exceeds the recoverable amount, a value reduction is necessary, also known as impairment. 30 (2) 20 (13%) Industrial manufacturing Financial services Life sciences and health care Technology, telecommunications and media Retail and consumer Energy and utility Real estate Chemical industry 22 (15%) The high expectations reflected in the goodwill, with regard to synergies and future growth potential, may pose major risks of impairment. The following therefore looks at the goodwill impairment testing practices of 151 SPI-listed corporations which compile balance sheets according to IFRS. The assessment covers the years It should be noted, however, that a higher goodwill per se, in absolute or relative terms, only permits limited conclusions. As long as the company concerned is profitable, and the cash flows and margins are right, higher goodwill may, in some cases, suggest a latent risk of impairment in unfavourable economic circumstances, but cannot have further implications. 13

14 Goodwill and balance sheet total Goodwill impairment testing in practice As our PPA appraisals have shown, goodwill has far and away the most importance, in a cross-sector comparison, in the fields of life sciences and health care as well as technology, telecommunications and media: more than 5. Accordingly, it comes as no surprise that these two sectors show the highest book values for goodwill, followed by the retail and consumer goods segment. The bar chart below also shows that, especially in the technology, telecommunications and media sector, the proportion of goodwill has risen from 8% to 13% over the past four years. This is due to continued transactions, especially in this sector, during the years marked by the economic and financial crisis. Hence goodwill, as a proportion of balance sheet total, has also risen continuously. Goodwill as a percentage of balance sheet total (%) 16% 14% 12% 1 8% % 9.2% % 13.3% 13.6% 7.9% 10.2% 11.4% 12.7% 8.5% 9.4% 10.6% 10.5% 7.2% 8.7% 8.1% 7.9% 6% 4% 2.3% 2.3% 2.2% 3.2% 2% 0.5% 0.3% 0.4% 0.4% 0.2% 0.3% 0.2% 0.2% Industrial manufacturing Financial services Life sciences and health care Technology, telecommunications and media Retail and consumer Energy and utility Real estate Chemical industry

15 Goodwill and equity Goodwill impairment testing in practice As a rule, goodwill and its impairment pose no problem during phases of economic upturn. However, if an economic downturn results in falling order books and turnover, margins and turnover and growth targets must be questioned and, often, revised. This may lead to goodwill impairment. When interpreting the bar chart below, it should be noted that a rise in percentage may be due both to an increase in transaction-related goodwill and to lower equity capital caused by losses. Goodwill accounts for an uneven proportion of equity. This not only highlights the sector-specific differences, but may also be viewed as an indicator of how great any repercussions on equity may be, in the event of goodwill impairment. This means that the influence on equity is strongest when the proportion of goodwill is high in relation to equity. Goodwill in relation to equity (%) 35% 3 25% 2 15% 21.4% 26.6% 22.2% % 11.9% 12.3% 11.3% 28.1% 21.9% 21.2% 24.3% 19.7% 24.3% 27.3% 29.2% 19.9% 22.1% 25.4% 26.8% 13.9% 24.3% 24.9% 19.9% 1 5% 1.1% 0.7% 0.7% 0.6% 0.2% 0.5% 0.4% 0.4% Industrial manufacturing Financial services Life sciences and health care Technology, telecommunications and media Retail and consumer Energy and utility Real estate Chemical industry

16 Intangible assets and balance sheet total Goodwill impairment testing in practice Our analysis highlights that the proportion of intangible assets (except goodwill) in the balance sheet total ranges from (real estate and property) to 12% (life sciences and health care). This reflects the differing significance of intangible assets such as client relationships, brands and/or technology, as described in the section on PPA. Apart from intangible assets of indefinite useful life (e.g. brands), the absolute level of intangible assets in the post-transaction years have an influence on trading profit which cannot be ignored, due to amortisation. Due to transactions during the past four years, in several sectors the relative proportion of intangible assets has risen. Intangible assets as a percentage of balance sheet total (%) 14% 12% 1 8% 6% 4% 4.5% 5.3% 6.1% 6.9% 3.6% % % 10.1% 9.5% 11.6% 4.3% 5.4% 6.8% 7.1% % 8.3% 4.1% % 5.6% 2% Industrial manufacturing Financial services Life sciences and health care Technology, telecommunications and media 0.6% 0.4% 0.7% 0.6% % Retail and consumer Energy and utility Real estate Chemical industry

17 Intangible assets and equity Goodwill impairment testing in practice As stated in relation to the PPA, intangible assets (excluding goodwill) usually represent a significant portion of the transaction volume. Thus, in the retail and consumer goods segment, and in manufacturing industry, we have seen a proportion of intangible assets amounting to 5 of purchase price. Three groupings are discernible from the bar chart below. One is of those where intangible assets play a subordinate role, because of the field of business (energy and utilities, real estate and property). Another is of those where the proportion of intangible assets has fluctuated (chemical industry, life sciences and health care, and manufacturing). Then there are others where intangible assets have risen steadily under a certain pressure to consolidate (retail and consumer goods, and technology, telecommunications and media). Proportion of intangible assets compared with equity (%) % 2 15% 13.7% 15.5% 16.4% 13.1% 11.6% 17.5% 12.9% 13.4% 14.3% 15.6% 13.4% % 15.6% 15.8% % 21.6% 15.8% 18.5% 13.8% 1 7.7% 8.1% 5% 1.2% 1.1% 1.8% 1.7% % % Industrial manufacturing Financial services Life sciences and health care Technology, telecommunications and media Retail and consumer Energy and utility Real estate Chemical industry

18 Size and frequency of goodwill write-downs Goodwill impairment testing in practice Number of companies with goodwill impairment (%) 3 25% 23.6% 24.3% As the graphs on the left show, the repercussions of the economic and financial crisis have increased the number of companies recording goodwill impairment. In 2008 and 2009, the level of that goodwill impairment in relation to the book value of the goodwill also lay well above the figures for the two preceding years. However, as previously shown, the goodwill levels in the books remain significant. 2 15% 15.8% 17.6% 1 5% Goodwill impairment as a percentage of book value of goodwill (%) 4.5% 3.9% 4.1% % 3.2% % 2.5% % % Noteworthy shifts in the field of goodwill impairment occurred especially in the following two sectors: In retail and consumer goods, in 2008 and 2009 roughly one company in four applied amortisation to goodwill, whereas only around one company in 15 had done this in the years 2006 and It was also striking, though no surprise, that in 2009 around one company in three in the financial services sector adjusted the value of its goodwill. 18

19 Contacts and authors Contacts Markus Bucher Head of Advisory Tel. +41 (0) Martin Schilling Advisory Director Tel. +41 (0) Authors Martin Schilling Dr. Jörg Altmann The authors wish to thank Olivia Senn, Philipp Elsässer, Jan Bolliger and Daniela Meletta for their support in preparing the underlying data and compiling the present study. Thomas Schneller Advisory Director Tel. +41 (0) PwC. All rights reserved. PwC refers to PricewaterhouseCoopers AG, which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity. 19

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