Corporate Finance - Goodwill and Goodwill Impairments

I will start this post by stating that I am not an accountant nor do have an MBA. I am an engineer/sales rep/wireline hand that is interested in corporate finances. I try to learn from as many different sources to understand the quarterly earnings reports issued by my customers and competitors so that I can get a clearer picture of their plans.  My goal in this post is to share a bit of knowledge that I've learned and give some clarity to quarterly reports.

Being an ex-Schlumberger Wireline hand, I usually go through Schlumberger's quarterly report to understand where they are heading and how they think the market is trending. They are usually one of the first oilfield service companies to publish their report and because they are the largest Oilfield Service Company, people pay attention to their reports

In Q1 2020 and Q3 2019, they showed large losses on their income statement due to impairments. The majority of the impairments were due to goodwill impairments. While goodwill is shown on the balance sheet, it is rarely discussed unless there is a decrease in the value of the goodwill.

Goodwill is created when a company acquires another company for more than the value of its assets. The premium paid cannot be attributed to any tangible or intangible asset. It is the premium the company was willing to pay over the fair market value of the company in order to acquire it. 

For example: Company A has a value (assets minus liabilities) of $10 Billion and Company B purchases that company for $13 Billion. Company B paid a premium of $3 Billion dollars, which will be recorded on their balance sheet as $3 Billion in goodwill. 

Goodwill is a huge asset on the balance sheet of many large companies, especially those who grow through acquisitions rather than organic growth. Goodwill can decline over time. If the synergies between the companies exist and produce benefits, then the value of the goodwill still exists. If that value decreases, then the value of the goodwill is reduced and that is counted as a goodwill impairment. 

Goodwill is consider an intangible asset and is recorded on the balance sheet as a long term asset. An intangible asset is an asset that is not physical. Examples of intangible assets are goodwill, brand recognition and intellectual property. Figure 1 is from Schlumberger's Q1 2020 earnings report and it shows their assets and liabilities for Q1 2020 and Q4 2019

Figure 1: Schlumberger Q1 2020 Earnings Report - Assets and Liabilities

Goodwill is the largest asset on the balance sheet, accounting for 27% of the total assets on the balance sheet. In the past decade, SLB has grown their business through acquisitions. Two of the largest acquisitions in the last decade were Smith International in 2010 and Cameron in 2016. 

As Figure 1 shows, goodwill decreased by $3.1 Billion dollars between Q4 and Q1. Going through the report, SLB stated that they performed an impairment test and found that some of the goodwill on their balance sheet was impaired due to market conditions, resulting in a $3.1 Billion charge. This charge was related to their Drilling and Production segments. 

US accounting standards require companies to evaluate the value of goodwill on a yearly basis, (usually in the third quarter) to determine the value of the goodwill. If the value of the goodwill has decrease, a goodwill impairment charge is recorded . The impairment test can also be triggered by a market event, such as a global pandemic resulting in massive loss of demand.

When looking at SLB's Income Statement, the goodwill impairment charge is recorded under the Impairments and Other line (Figure 2). 

Figure 2: Schlumberger Q1 2020 Earnings Report - Income Statement

The total impairments for Q1 2020 were $8.523 Billion. Figure 3 shows the list of impairments that were recorded during the quarter

Figure 3: Schlumberger Q1 2020 Earnings Report - Total Impairments

When looking back to Q3 2019, Schlumberger recorded $12.7 Billion in impairments. There were $8.8 Billion in impairments associated with goodwill. As part of the third quarter impairment test, they realized that the value of the goodwill associated with Cameron and Smith International had decreased and they were required to take a goodwill impairment charge. Figure 4 shows the list of impairments from Q3 2019

Figure 4: Schlumberger Q3 2019 Earnings Report - Total Impairments

When Baker Hughes released their Q1 earnings, they showed a $10.2 net income lost which can be attributed to a goodwill impairment charge of $14.7 Billion. Figure 5 shows the Consolidated Income Statement for Baker

Figure 5: Baker Hughes Q1 2020 Earnings Report - Income Statement

Figure 6 shows the breakdown of the goodwill impairment charges for the quarter. The majority of the charges come from the Oilfield Services and Oilfield Equipment segments

Figure 6: Baker Hughes Q1 2020 Earnings Report - Goodwill Impairment Summary

When reading the quarterly report and listening to the earnings call, Baker does not reveal the details of the impairment test or details of the loss of goodwill. They are required to report impairment charges but they are not required to provide details. 

As earnings report continue to come out, we should expect to see more impairments on income statements. The decline in oil prices has significantly reduced the market value of companies. The variables that went into deciding purchase prices for companies (future earnings, break even prices, acreage ranking) have changed radically in the past month. The premiums paid by companies to acquire competitors do not look very good under present market conditions and those goodwill impairments will appear on balance sheets in coming months.