Devaluing the Good in Goodwill

When used in finance, the term “goodwill” doesn’t refer to benevolent and kindly feelings about a company.  But right now, many businesses probably wish that it did.

Instead, goodwill is actually an intangible asset on a company’s balance sheet.  It is created when a company acquires another company for a price in excess of the net fair value of the company’s assets minus liabilities.  The excess amount represents the perceived value of customer relationships, brand recognition, future strategic value, etc.  But in fact, goodwill is so intangible that some accounting experts disparage it as nothing more than “air”.

Here’s an example of goodwill that has gone down in financial folklore.  Amazon paid $13 billion for Whole Foods in 2017 – and $9 billion of that was allocated to goodwill on Amazon’s balance sheet.  Thus, Whole Foods’ actual value was only $4 billion, or 31% of what Amazon paid for the company.

Companies are required to test and adjust the value of their goodwill on a yearly basis, and any reduction hits the income statement as an impairment charge.  And if there happens to be an odd and unusual event, it triggers additional impairment tests.

Not surprisingly, COVID-19 qualifies as such a trigger and has blown-in a storm of goodwill impairments.  Hard hit cruise line Carnival Corp. took a $731 million impairment charge in April, and oil company Baker Hughes said it would record a $15 billion impairment due to plunging oil prices as a result of the pandemic.

That’s pretty expensive “air”, and when the dust settles and the clouds clear, there will probably be changes in how goodwill is valued and recorded.  In the meantime, look for more big write-downs in future earnings reports.