GM — Holy negative accounting equity, Batman!

Apparently GM is going to take a $39 billion dollar writedown of deferred tax assets this quarter. Wow.

The phrase “deferred tax assets” is one of many powerful hexes the accounting profession has invented over the years. Recitation of the words before ordinary mortals causes eyes to glaze and specks of spittle to appear at corners of the mouth. For an explanation, see the end of this post.

Anyway, as all the overnight press on the matter is careful to emphasize, these are non-cash charges, and they could be reversed if GM becomes profitable soon. Nothing to look at here, just move along. It’s an accounting thing, you wouldn’t understand.

But here’s an accounting thing for you. Check out GM’s top-level balance sheet last quarter (the quarter ending Jun-07). Look at the line called “Total stockholder equity”. Yes, it really does say negative 3.5 billion dollars.

Suppose GM offsets the writedown of tax assets with $9B of gains elsewhere, so that the net charge is, um, only $30B. (For example, they’re expected to report a gain of $5B on their sale of Allison Transmission.) A $30B net charge would bring GM’s accounting equity down to negative 33 billion dollars.

Is that a record? What’s the maximum negative accounting equity ever reported by a going concern? Or, consider this: GM is not a penny stock. The market imputes a lot of real value to those claims worth negative dollars on its balance sheet. GM’s market cap as of yesterday was about $20.5B. That’s a positive number. GM’s stock price fell after-hours on announcement of the charge by about 3%. So, incorporating (at least partially) the new information, the market imputes about positive $19.9B of value to roughly negative 30 billion dollars worth of book assets. There’s a nice fifty-billion dollar spread between market and book value. If GM could keep that spread, but bring its book value up to positive a billion, it would look like an incredible growth company, with a market to book ratio of 50 times! Google looks cheap by comparison.

Now, there are serious problems with accounting equity as a measure of value. GM is an old company. Perhaps it owns a lot of real assets that were purchased decades ago and are still valued on its books at 1940s cost. Could be. But it takes a lot of adjustments to get out of a hole $30B deep.

An interesting factoid from the WSJ. GM’s total net income for 1996 through 2004 totaled $34 billion dollars, less than is disappearing in tomorrow’s accounting “poof”.

Here’s a question: What percentage of GM’s market valuation do you think is based on a market-perceived “too big to fail” guarantee by the US government?

For those who want to know, “deferred tax assets” arise when firms recognize expenses before they are allowed to take a tax deduction for those expenses. Let’s say a large New York bank decides some of its assets are worth 10B less than originally thought, and writes those assets down on its balance sheet. If the bank pays a 35% tax rate, 3.5B of that “loss” should eventually be absorbed by the government in the form of reduced tax payments. But companies don’t get to pay fewer taxes whenever they change their estimate of the value of an asset. The bank gets a cash write-off on its taxes only when the assets are actually sold and the firm realizes a loss. In the meantime, the firm recognizes a 3.5B “tax asset”, the value of the future tax savings it expects. This is all perfectly legitimate — writing down the assets without recognizing the expected tax-savings would badly overstate costs. But sometimes a firm’s estimate of future tax savings turns out to be wrong. Say the bank is forced to sell the impaired assets when it is already losing money. Then there is no immediate tax savings, because the bank wouldn’t have paid taxes that year anyway. The firm may still be able to “carryforward” the loss, and recover some of the tax savings. Or it may not. Tax laws are complicated.

GM had previously estimated that it had $39B in future tax write-offs coming to it. Its accountants now think the company might never get the chance to use them. Though this is not a cash charge, it is not a good omen either. Firms realize tax assets when they are profitable enough to have a large tax bill to take deductions from. GM is basically announcing that it’s unsure it will earn enough money to be able to take advantage of its pent-up tax offsets before they expire. Tax asset writedowns are insult-to-injury kind of events. Firms get hit with the accounting charge when, and precisely because, they can’t make enough money to have a tax liability to escape from.

Tax asset writedowns might also be a signal of distress, indicating that a firm lacks the flexibility to time its loss realizations advantageously. Tax laws are complicated, and sometimes tax benefits expire regardless of what a firm does. One mustn’t draw conclusions. Still, it does make you wonder.

FD: I have no direct position in GM, but I am short the Dow.

Update History:
  • 07-Nov-2007, 11:33 a.m. EST: Changed “tax asset write-offs” to “tax asset writedowns”, since I use “tax write-offs” and the mix is confusing. Changes “to big to fail” to “too big to fail”.

7 Responses to “GM — Holy negative accounting equity, Batman!”

  1. Great post. Here’s another way to look at it. GM has 566 million shares and the Dow divisor is about 0.123. Therefore, the charge is the equivalent of 560 Dow points.

  2. How hard would it be for GM to find someone with whom to merge so they could take advantage of this asset?

  3. Eddy — After today’s market action, your comment looks prescient…

    byrneseyeview — It does seem like leaving a lot of money on the table, doesn’t it? But merging with GM would be a pretty high-risk proposition, there’s a lot of debt, negative equity, but you’d still have to pay to buy them. It would take a very, very profitable company to make good on 39B in tax assets (you’d need roughly 120B in profit (not revenue, mind you, but earnings-before-tax), to take advantage. When you consider that, the previous existence of these assets on GM’s books begins to look, well, sketchy. If 34B was GM’s 8-year profit during a relatively good period in its recent life, under the most optimistic turnaround scenarios it’s hard too see how anything more than a small profit of those former assets could have been used. I think it’s fair to say that this is really an earnings quality issue, that GM has been consistently overstating earnings in the form of tax assets it could never make use of, and as the vultures hover and the accountants think back to Arthur Anderson, they’ve been told it won’t fly any longer.

    Anyway, I think that for a very profitable firm to buy GM for pent-up tax-deductions would be very risky, considering GM’s huge debt position and the scale of potential future losses. Still, as the stock price approaches the firm’s accounting equity, recovering those might be frosting on the cake for a buyer, if anyone is bold enough and foolhardy enough to try to save the automaker. I’m sure there are lots of complexities involving taxation and mergers that would have to be considered. But who knows? Maybe GM’s potential value as a tax shelter will attract some white knight?

  4. Test writes:



  5. Test writes:



  6. Thomas writes:

    Book value? Who looks at book value anymore? The accounting profession gets so wound up about the value of assets but forgets that most of a company’s balance sheet is meaningless. What counts is a company’s forward cash flow generation ability. Sometimes that is related to the assets on the balance, sometimes not. I get very amused when I hear people talk about valuing companies using a Price to Book Value Ratio. EV/EBITDA — actually, forward EV/EBITDA is the only thing that matters. In fact, one could argue that a company that creates a greater cash-flow generation capability with a LOWER level of assets is a superior business.

  7. cqkgjytmwg writes:

    cqkgjytmwg cqkgjytmwg cqkgjytmwgcqkgjytmwg

    cqkgjytmwgcqkgjytmwgcqkgjytmwg cqkgjytmwg