tag:blogger.com,1999:blog-7294165939647321702.post1713422426276125481..comments2024-03-11T10:31:06.107-04:00Comments on <center><a href="http://www.barelkarsan.com">Barel Karsan - Value Investing</a></center>: HP Stock Gets DestroyedSaj Karsanhttp://www.blogger.com/profile/04493152766022812984noreply@blogger.comBlogger5125tag:blogger.com,1999:blog-7294165939647321702.post-84353996501308393952011-08-30T10:20:01.912-04:002011-08-30T10:20:01.912-04:00Saj,
It was surprising to me when I first realize...Saj,<br /><br />It was surprising to me when I first realized this, but it seems that many tech companies have very large quarterly amortization charges for "acquired R&D". I also thought that the difference between book value and purchase price was all considered Goodwill (which is not amortized anymore), but apparently not. For example, in the 9 months YTD for FY2011, HP has expensed $1.2B in "Amortization of purchased intangible assets". That's quite significant, seeing as their EBIT over this same period was $8.9B.<br /><br />In thinking about this accounting issue, I think it's conceptually useful to separate "Maintenance R&D" from "Growth R&D". Maintenance R&D represents the spending required to maintain the current level of software/hardware sales - things such as bug fixes, new software/hardware versions, and feature additions that are required to maintain sales at the current level. Growth R&D is spending required to expand into new product areas and grow sales.<br /><br />Using the above definition, I think it's clear that the expensing of R&D for acquired companies and the amortizing of acquired intangibles are *not* separate issues. If an investor believes that the ongoing R&D spent on the acquired products is at least equal to the R&D required to maintain those products (which is fairly conservative because often times growth R&D is being expensed as well), then it doesn't make sense to amortize the acquired intangibles.<br /><br />Having said all that, I think I do see your point to a certain degree. In an environment of rapidly changing technology, maybe it's not always possible to "maintain" a product perpetually just by spending money on typical engineering/marketing salaries and evolving the product "naturally". Maybe sales are always destined to decline over time for the acquired products, even though the engineering and marketing people working on those products continue to get paid every year. If that's the case, then I'd agree that it's not appropriate to add back those amortization charges.<br /><br />- aagoldAnonymousnoreply@blogger.comtag:blogger.com,1999:blog-7294165939647321702.post-29858782308188911372011-08-29T23:16:42.794-04:002011-08-29T23:16:42.794-04:00Hi aa,
You raise an interesting question, but I&#...Hi aa,<br /><br />You raise an interesting question, but I'm not sure I agree. First, I would argue that most of the difference between book value and purchase price is allocated to Goodwill, which doesn't get amortized. To the extent that there are intangibles booked other than Goodwill, I would argue that adding those amortized amounts back (for the purposes of estimating earnings power) requires a belief on the part of the investor that the company no longer needs to buy new companies to maintain its earnings power (which may be true, but must be evaluated).<br /><br />The fact that the company will expense the R&D costs of the acquisition going forward is conservative, I agree, but is a separate issue IMO. Because what is being developed from now on is hard to value, that accounting treatment is likely appropriate unless the investor can prove otherwise.<br /><br />Am I understanding what you are asking or am I missing the point?Saj Karsanhttps://www.blogger.com/profile/04493152766022812984noreply@blogger.comtag:blogger.com,1999:blog-7294165939647321702.post-34333839129318078252011-08-27T00:13:30.539-04:002011-08-27T00:13:30.539-04:00Saj,
Well let's back up a step to clarify som...Saj,<br /><br />Well let's back up a step to clarify something. Let's consider a technology company that is operating on its own without doing any acquisions. Should the cost of its R&D be expensed as incurred, or should the cost be capitalized on the balance sheet? Almost all tech companies I'm aware of do the more conservative type of accounting - they expense R&D as incurred, and therefore they don't have any R&D "assets" to amortize later. But if a tech company does capitalize its R&D expense, then it will also have to amortize the previously capitalized expense over time.<br /><br />But when a tech company does an acquisition, it seems to me that it's *both* amortizing the acquired R&D asset *and* expensing the salaries of the engineers it just acquired. Do you see my point? I mean, let's consider the very first year after a startup company is acquired. Obviously the company is still paying the salaries of the engineers it just acquired, and it's hard to believe those engineers are already obsolete. Well if this R&D is being expensed as incurred, isn't it double-counting to *also* amortize the acquired R&D?<br /><br />- aagoldAnonymousnoreply@blogger.comtag:blogger.com,1999:blog-7294165939647321702.post-69482868045818195632011-08-26T22:34:36.008-04:002011-08-26T22:34:36.008-04:00Hi aa,
I think it all depends on whether the comp...Hi aa,<br /><br />I think it all depends on whether the company can internally generate (with the R&D dollars you talk about) new technologies that replace the acquired technologies that will go out of date. When the technologies change so fast, I think it's harder to do; so a company may have to just keep acquiring new expertise, in which case you shouldn't be adding back the amortization expense. So I guess it would come down your judgement of whether HP is adding to its expertise with acquisitions, or merely replacing expertise that is now obsolete.Saj Karsanhttps://www.blogger.com/profile/04493152766022812984noreply@blogger.comtag:blogger.com,1999:blog-7294165939647321702.post-31143759153898338882011-08-25T07:33:22.133-04:002011-08-25T07:33:22.133-04:00Saj,
I'd be interested in your opinion on an ...Saj,<br /><br />I'd be interested in your opinion on an accounting issue. For companies such as HP, who have done a lot of acquisitions in the past, I add back after-tax amortization of purchased intangible assets to compute an "adjusted" version of reported GAAP earnings. On that basis, HP is a lot cheaper than you said. In fact, if you use their reported "non-GAAP earnings" (which also adds back restructuring charges but does *not* add back stock-based compensation), then HP currently trades an a P/E of just 4.7! <br /><br />You wrote about the general subject of amortization of intangibles in a recent post, but I wanted to discuss this issue specifically for tech companies, acquisitions, and R&D. Here's my thinking. I think it's safe to assume that management does not lay off the R&D engineers from the acquired company. Therefore, the value of the acquired software or hardware IP is at least maintained over time by way of ongoing R&D. Since that R&D is expensed as incurred, it's double counting to also amortize purchased intangible assets.<br /><br />- aagoldAnonymousnoreply@blogger.com