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JANUARY 11, 2002


By Robert Barker

AOL Time Warner's "Goodwill" Games

A closer look at the arcane accounting used to value the merged company has to make you wonder what it's
really worth
However badly you've done in judging stock market values the past couple of years, be thankful you didn't make a mistake to the tune
of perhaps $60 billion. That little boo-boo came courtesy of AOL Time Warner (AOL ). The new media/old media monolith this week
conceded, at the very bottom of a long financial news release, it will be writing down the value of its assets by somewhere between $40
billion and $60 billion.
In a conference call with Wall Street analysts, AOL Chief Financial Officer Wayne Pace made it clear that the extraordinary charge -potentially an all-time high -- will not involve any hard cash leaving the company. "It does not affect operations," he said.
Instead, it represents AOL Time Warner's decision to mark down the value of the intangible assets AOL picked up when it closed the
Time Warner deal just one year ago. The accounting here can get eye-glazing fast. But it's worth examining quickly, if only for what it
tells us about valuations in the funny-money stock market vs. those in the real world of doing business.
THE $128 BILLION PLUG. AOL paid for Time Warner not in cash but in stock: 1.5 AOL shares for each Time Warner share. Total
cost, including transaction charges: $147 billion, mostly the value of some 2 billion new AOL shares. They had been trading in the mid$70s when the deal was cut.
Next, the accountants got to work. To blend Time Warner's balance sheet into AOL's, the bean counters had to figure out how to
allocate that $147 billion. First, they toted up the fair value of Time Warner's net assets -- its cash, receivables, real estate, and such -and recorded those amounts on AOL's balance sheet. Yet the total of those identifiable assets came up considerably short of $147
billion. To plug the hole, the accountants added a breathtaking $128 billion to a item on AOL Time Warner's balance sheet called
"goodwill and other intangible assets."
This is a line you'll find on most every public company's balance sheet. It acts as a sort of catch-all to account for otherwise
unaccountable premiums that companies pay for assets, especially in mergers. Trouble is, companies don't always pay the right price in
mergers, or at least a figure that can be justified some quarters later when the assets they bought fail to hold their imagined value.
REASON TO PAUSE. That's where the $40 billion to $60 billion comes in. AOL Time Warner, spurred on by a new rule governing how
goodwill is accounted for, now is acknowledging it doesn't really have $128 billion worth of intangible assets. It has $88 billion or $68
billion, depending on whether its final write-off is $40 billion or $60 billion or somewhere in between. Just that spread -- 20 billion bucks!
-- ought to give investors reason to pause over the volatility of stock market valuations, the vagaries of corporate accounting, and
anyone's ability to judge the real, ongoing worth of a business.
This $20 billion gap indicates that, even now, two years after AOL and Time Warner announced the merger agreement, executives can't
be sure of the true value of the assets they purchased. How much is Warner Bros.' film library worth? The catalogue of copyrighted
music? Cable-television franchises? The brand name Home Box Office? Magazine subscriber lists? CNN? The Atlanta Braves baseball
team? How much, for that matter, is it worth to control all of these assets?
These are the imponderable intangibles that, back at the dawn of the new millennium, AOL valued at $128 billion in its own shares.
Now, as AOL executives and accountants catch up with the market's bloodless verdict, the company is conceding they're worth $40
billion to $60 billion less.
THAT SINKING FEELING. Who's left holding the bag? Investors who bought shares in AOL back, say, in December, 1999. It peaked
that month near $96 a share. The following month, when AOL and Time Warner announced their plan to merge, AOL's share price had
already fallen to the mid-$70s. A year later, when AOL actually had to issue 2 billion new shares and give them to Time Warner's
shareholders, the stock's price had sunk into the mid-$40s.

Investors who held on now own shares that are worth still less, about $32 each. As AOL noted, its mammoth write-off of goodwill will not
affect the company's own operations. But you can bet plenty of its shareholders have already suffered a dent in theirs.

Barker covers personal finance in his Barker Portfolio column for BusinessWeek. His column appears every Friday,
only on BusinessWeek Online

Edited by Patricia O'Connell

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