Accounting for a Strange World

On the basis of pure math, the second deed — which was performed by AOL/Time-Warner — is 80 times worse than the first one — performed by troubled Enron.

Enron is pretty much history now — the victim of a calamitous decline in its stock price. But AOL/Time-Warner’s write-off — announced January 8, 2002 — raised nary a whimper on Wall Street or in the press that covers it.

In fact, the price of its stock declined only 85 cents on the day after the write-off was made public. Even two weeks later, AOL stock held relatively steady at just under $30 — a mere $2 less than its value on the day before the announcement.

Is this lack of media attention to AOL/Time-Warner’s drastic write-off a conspiracy? Or is something else going on?

After all, $50 billion dollars was simply wiped from the company’s books in one day. If $50 billion disappeared from the vaults of a bank, the FBI and police would be mobilized. If the U.S. federal government suddenly changed its budget by $50 billion … well, that happens all the time.

But where are the bloodhounds of the financial press in the pursuit of this story? Where are the headlines? Isn’t the loss of that much money worth more than short items buried in the inside pages of the business section?

Of course, these days nobody would argue that the financial press is infallible. But in the AOL/Time-Warner case, there is a crucial reason why reporters — and, perhaps more important, financial markets — reacted to Enron’s $600 million loss with screaming headlines, while they almost ignored AOL/Time-Warner’s $50 billion write-off.

The main reason for this seeming double standard is not that AOL/Time-Warner’s top management paid off reporters, or that the press is somehow biased against Enron. Put simply: Enron’s $600 million plus drop was a complete surprise — and AOL/Time-Warner’s drop of $50 billion wasn’t.

AOL announced its merger with Time Warner to much hoopla in January 2000. But intelligent observers of both companies wondered at the time about whether the sum of the two companies was worth so much more than the parts.

In fact, both AOL/Time-Warner’s respective share prices fell sharply. AOL was valued at $72 a share when the announcement was made. It slid to $60. Time Warner dropped $20, from $99 to $79. Two years later, the write-off has validated that initial skepticism.

It’s difficult to plot out exactly where that $50 billion has gone. It was recorded in the merged company’s books as “goodwill” — a bookkeeping catch-all designed to account for the increased value of the two companies’ newly-merged stock. This “goodwill” measures value beyond tangible physical assets such as buildings and equipment.

When the U.S. stock market turned south, it no longer thought so highly of the marriage of AOL/Time-Warner. And new accounting regulations required that company adjust the “goodwill” on its balance sheet to accurately reflect its lower share price.

A number of companies have been affected by the change, including fiberoptic producer JDS Uniphase, which wrote off almost $50 billion in 2001.

As jarring as it seems, however, AOL/Time-Warner’s sizeable write-off constituted a simple technical change that was well understood by the market. More importantly, this “goodwill” gesture didn’t involve actual dollars. Thus, the company didn’t feel a crunch in its cash flow — and thus did not have to send out urgent call to its lenders.

What killed Enron was its nasty surprise for the market. Until October 16, 2001, Enron was viewed as a high-flying, but fundamentally sound company.

The shocking $638 million loss — little as it was in the bigger scheme of things, such as triple-digit billion mergers — proved this view wrong.

The loss also made Enron’s plight very big news indeed. Enron’s staggering loss turned the entire investment community’s view of the energy giant on its head. Meanwhile, AOL/Time-Warner’s $50 billion write-off did not fundamentally change anyone’s basic estimation of the company.

And that is why, in the financial world, it often is the smaller fiscal punch that proved to be a knockout.