The burst of the DAX 30 Goodwill Bubble

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As a result of low interest rates, Germany’s biggest companies have made risky acquisitions that led to a tremendous amount of so-called “goodwill” on their balance sheets. The effects of the current corona crisis imply impairment tests for all existing goodwill figures and their results might threaten the existence of entire companies. Where did things go wrong?

Goodwill is an intangible asset that arises from company acquisitions. It is the difference between the purchase price and the fair market values of the acquired net identifiable assets. It reflects growth potentials, synergies, market access, or very often it is the result of significant overpayments when managers want to seal the deal at “any price.”

Goodwill at DAX 30 companies

I have examined the recent financial statements of the DAX 30 companies. As of now, they show a total of €298 bn. in their balance sheets, an increase of €100 bn. compared to the year 2011. These €298 bn. represent on average 33% of the DAX 30’s equity, not to mention some extreme cases: Fresenius, a health care company, has €25.7 bn. in goodwill, which is slightly more than its total equity (€25 bn.); Bayer, as a result of its Monsanto deal, has €34.7 bn. in goodwill (73% of its equity); and Deutsche Post reports a goodwill figure (€11.3 bn.) that represents 79% of its equity.

Accounting implications of the coronavirus crisis

International accounting standards dictate that goodwill be tested for so-called “impairment” on a yearly basis, or if there is an indication. As a result of this test, there is impairment if the goodwill’s book value exceeds its fair market value. Indications of such necessary write-offs are market value declines and negative changes in the economy. It goes without saying that the current coronavirus crisis with its all-encompassing deterioration of economic conditions necessarily implies impairment tests for all existing goodwill figures: the assumed growth rates and expected cash flows at the time of the acquisitions, which may have justified the goodwill in the past, definitely can’t be sustained anymore in the face of the current coronavirus crisis.

A Threat to Companies' Existence

What every stakeholder and investor now needs to understand is that the results of these impairment tests will lead to extremely bad news: Germany’s biggest companies will have to make significant write-offs of goodwill in the near future, which will drag their profit and loss statements even further into the abyss. What is probably even worse: these often-risky acquisitions (see the Monsanto deal) have been financed so heavily by debt in the past. Writing off tremendous goodwill amounts that represent significant amounts (or even almost all) of equity will lead to a steep rise in the debt-to-equity ratios. This rise will lead to breaches of debt covenants with further severe consequences, and could even be a threat to some companies’ existence. Now, the fact that managers failed to value goodwill conservatively and prudently in the mandatory annual impairment tests in the past is coming back to haunt them.

Why Accounting Conservatism Should Be Practiced

As an academic teaching the fundamentals of international financial accounting and prudent accounting behavior here at KLU, I am disillusioned that managers did not practice accounting conservatism in the past and believed they could get away with it. Especially in times of crisis, it always shows that acting prudently in financial accounting is done for a reason. Although not terribly popular, accounting conservatism should always be practiced, that is, also in “good” times because it prepares us for the “bad” times. With regard to goodwill, top management showed a significant lack of prudence that has now backfired. With the coronavirus crisis there is no way to avoid tremendous impairment write-offs. The goodwill bubble in the DAX 30 will burst with quite a pop.

Corona Crisis: Analyses & Comments
This news is part of the Corona series of analyses and comments with KLU researchers regarding different aspects of the effects of the ongoing coronacrisis on our daily lifes, the economy, our way we work and more. Find all analyses and comments.  

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