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Welcome to Industry Focus, the podcast that dives into a different sector of the stock
market every day. Today is Friday the 13th, so we're talking tech write-offs and yadda
yadda yadda. I'm joined today by Dylan Lewis, but before we dive in, we're going to play
a short clip.
Cosmo Kramer: Hey, you got it!
Jerry Seinfeld: Hey! What happened to my stereo? It's all smashed up!
Kramer: That's right. Now, it looks like it was broken during shipping, and I ensured
it for $400.
Seinfeld: But you were supposed to get me a refund!
Kramer: You can't get a refund, your warranty expired two years ago.
Seinfeld: So we're gonna make the post office pay for my new stereo now?
Kramer: It's a write-off for them. Seinfeld: How is it a write-off?
Kramer: They just write it off. Seinfeld: Write it off what?
Kramer: Jerry, all these big companies, they write off everything.
Seinfeld: You don't even know what a write-off is.
Kramer: Do you? Seinfeld: No. I don't.
Kramer: But they do. And they're the ones writing it off.
O'Reilly: Dylan, you don't even know what a write-off is.
Dylan Lewis: I love that clip so much.
O'Reilly: That show ... I was so happy, because it's free on Hulu now. I was 12 and I would
watch it with my dad, and wouldn't quite get it. But now it's gold. (laughs)
Lewis: It's the same thing for me. I remember being young, and my dad was just laughing
on the couch, and I was like, "Wait, what's so funny?" (laughs) It was way over my head.
I was downstairs in the gym running maybe two weeks ago, and that clip played, that
episode, and I was just like, "We have to do a show about this."
O'Reilly: "We have to do a write-off episode!"
Lewis: Yeah, because I'm sure that's how the majority of people feel when I hear someone
talking about a write-off.
O'Reilly: Right. So, what is the technical definition of a write-off to the IRS? How
would you explain it to the layman?
Lewis: Most people, when they hear "write-off," they're thinking about a tax deduction, so,
something that lowers your taxable income. Kramer, in this clip--
O'Reilly: (laughs)
Lewis: I think he's talking about line items that are designated to account for shrinkage
or damaged products? I don't think he knows what he's talking about. So, most people think
about the tax side of it. There's more on the retail side. I'm sure Vince could talk
about this on the show sometime. Most retailers have accounts set up to compensate for either
shrinkage, so, stolen products, or damaged products, things that get lost somewhere or
aren't sellable for whatever reason. Maybe they get returned out of season, and they
just know they're going to take a loss on that item. There's some notion of a write-off there.
But today we're going to be talking about more corporate-side write-offs, less personal ones--
O'Reilly: (laughs) I can't stop laughing.
Lewis: --and a couple really big ones that have hit the tech sector.
O'Reilly: Okay. So, Kramer is obviously a moron, doesn't know what a write-off is. We
know it's basically just writing things off for corporations. Are there any major types
we should know about? Because you obviously have the broader, "Oh, we took a loss." But
what about accounts not being paid for something?
Lewis: Yeah, more on the investing side, and looking at companies, I think one of the big
ones to be aware of is this idea of an uncollectible account. When you have companies working in
a B2B setting, they'll have customers, and a lot of them will have available lines of
credit. They'll have terms like 2/10 net 30, or something like that. You pay in a set amount
of time, you get a discount; beyond that, you pay the full amount.
O'Reilly: Right. Oh, I remember doing that stupid stuff in accounting class ...
Lewis: (laughs) Does that ring true to your accounting classes in college? So, basically,
the way that works is, they made the sale, but for accounting purposes, they record the
transaction in the accounts receivable portion of the balance sheet. Accounts receivable
is basically an asset line item that says, "We made this sale, it's there, but we don't
have the cash yet." The idea is, once you get paid, you have that money in cash, so
you would reduce the amount from accounts receivable, that money would go to cash, everyone's happy.
O'Reilly: For everybody listening, you'll find this on every balance sheet, basically.
Everybody has accounts payable and accounts receivable.
Lewis: Right. It keeps business flowing. You don't always need to have the money on hand
to pay whatever you're paying. If you have a long-standing relationship with a supplier,
you've built up trust, they know you're going to pay. Of course, there's always the situations
where people don't pay. That's where you run into issues. Most major companies have an
estimate of bad receivables. It'll typically be on a timeframe basis. So, they know 95%
of receivables that are still within the first month are going to be paid, 90% within the
first six months, and then if something has been outstanding for more than a year--
O'Reilly: Probably not getting that sell.
Lewis: --there's probably a 50% chance or 30% chance of getting paid. So, that number
is built in that way. One of the ways this also manifests itself, and this is something
that investors might want to be aware of, is when you have a company filing for bankruptcy.
O'Reilly: Oh, man. (laughs)
Lewis: A very high-profile example of this that applies to tech is Circuit City's bankruptcy
in 2008. At the time, they'd had debts around, I think, $2.3 billion. You look at their major
creditors at the time, not surprisingly, a lot of major tech companies. That's what they
were selling. O'Reilly: Right. Dell, HP, Microsoft, all those guys.
Lewis: Yeah, the biggest one was Hewlett-Packard, who was owed just under $120 million.
O'Reilly: Wow. That's a lot of printers they gave them.
Lewis: (laughs) Right? Samsung was like $116 million. Sony was about $60 million. The thing
to be aware of here is, if you see a major retailer or a major distribution outlet for
hardware manufacturing or whatever going out of business, those companies probably aren't
going to be collecting 100% of that money they're owed. If they're lucky, they're probably
going to get about half. But realistically, there's some times where you're getting pennies
on the dollar in this situations, with these bankruptcy settlements.
For a company like HP, Samsung, and Sony, these are huge companies. It's not going to
have a meaningful impact on them. But, there was another creditor on that list, Garmin.
O'Reilly: They needed the money.
Lewis: Yeah. They were only owed about $15.4 million, but analysts at the time expected
that it could impact them on a $0.06 per share basis if they weren't able to collect on any
of that balance. O'Reilly: That's meaningful.
Lewis: Yeah. And Circuit City at the time was a little bit under 2% of Garmin's sales.
Depending on the size of the company and the relationship they have, it's something you
definitely need to be aware of.
O'Reilly: Yeah, and not only that, but when that retailer goes away, that's a 2% swing
in your revenues. That definitely happens. It's always funny to me, it doesn't happen
a lot, but, in another retailer situation, not a tech one, but J. C. Penney two years
ago, when the word bankruptcy was being thrown around, even though they didn't, holiday season
ran around, and they actually did a share sale just so they would have the cash on hand
so people would send them clothes to sell at Christmastime. Everybody was like, "No,
we're not going to send you clothes unless ... " Like, Ralph Lauren wanted to make sure
they were going to get paid, and they were kind of withholding.
Lewis: Yeah, another example of that going on right now outside of the tech space, if
you look at Sports Authority, two of the largest creditors in the publicly-traded sphere for
Sports Authority are Nike and Under Armour. The idea is, they've given them supplies,
and they're waiting to get paid for them. So, that's a story to watch if you want to
see how this topic develops and get a better sense of it. Watch the news items as they
relate to that bankruptcy. I think they'll do a really good job of illustrating that.
O'Reilly: Awesome! Before we move on, here at The Motley Fool, we talk a lot about investing.
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A great way to do that, of course, is audiobooks, which is why we're so excited to be partnering
with audible.com. As I mentioned before, they have over 250,000 fiction and nonfiction titles,
one of which is a book I've recommended to Dylan numerous times, which is "Adventure
Capitalist" by Jim Rogers.
Lewis: Yeah, you've really sold it, I have to be honest. I haven't not tried it because
of my own reluctance. I've been listening to podcasts and stuff. But I've gotten through
that backlog, and I'm excited to give it a shot. Can you give us a two-sentence description on this?
O'Reilly: Two sentences ... Jim Rogers was a hedge fund manager in the 60s and the 70s.
He was actually the first business partner of George Soros, the hedge fund manager who
lives and works in New York. Jim Rogers retired in like 1980, he has like $100 million and
just hangs out now. And he writes books and all this stuff. But, he went around the world
twice. 130, 140 countries. The first time was in the early 90s, and he did it on a motorcycle
with his wife. And he writes about his journeys, what he learns about investing in each of
these countries. It's awesome, because he did it again, in a car this time, in the book
"Adventure Capitalist." And he starts in Ireland and he zigzags all through Africa, Europe.
They put the car on the Trans-Siberian railroad. It is awesome. And he talks about investing
insights and insights about people in his travels.
Lewis: It sounds like I'm going to have a pretty riveting metro commute for the next
week or two.
O'Reilly: Cannot recommend it enough. Moving back into talking about write-offs, talk to
me about write-downs. People do need to estimate, especially in tech, they're like, "OK, we're
going to spend $1 billion making this new computer chip, oh no, it doesn't actually
work ... " How does that happen?
Lewis: In the previous example, with accounts receivable, you thought you were getting x
amount, and you actually wound up getting y amount, and you had to write down for that.
It's a similar idea with write-downs. Most of the time, you see this with acquisitions
or in the goodwill space, where what you thought was worth x was actually worth y. That's the
best way I can explain it for you.
As a refresher, we've actually talked about goodwill a little bit. I think we did the
show, 'everything you wanted to know about tech but were afraid to ask.' We talked about
Facebook's goodwill with the WhatsApp acquisition. But goodwill, basically, when one company
acquires another company, there's the book value for that business, and then there's
what the acquirer actually wound up paying. There's usually a premium with any acquisition,
it just happens. But they attribute that premium to the intangible assets like brand, established
customer base, the employee culture there, things that seem to add value to the business,
but you can't tie a direct dollar amount to. That premium is what goes on the balance sheet
as goodwill.
Of course, you either wind up realizing that value or you don't. Sometimes you have to
pay the piper and say, "OK, turns out it didn't really work out," or, maybe in the case of
Facebook and Instagram, "This has been Gangbusters for us, and it's incredible."
O'Reilly: This is actually funny to me, WhatsApp keeps adding users, and I'm starting to wonder,
will they get about $20 billion in value out of them? That'd be cool. Anyway, do you have
any bad examples for us?
Lewis: Yes. In the case of Microsoft's acquisition of Nokia--
O'Reilly: What's Nokia? Lewis: (laughs)
O'Reilly: I'm kidding. (laughs)
Lewis: Yeah, right? Oof. So, in April of 2014, Microsoft acquires Nokia's phone unit. They
bought it for about $9.5 billion--
O'Reilly: (laughs) I didn't know it was that high!
Lewis: That does include $1.5 billion in acquired cash.
O'Reilly: Whatever. (laughs)
Lewis: Depending on how you see it stated, it might be closer to $8 billion, as reported
by some outlets. This was, of course, a deal in the Steve Ballmer regime--
O'Reilly: He bought Skype for $8 billion, too, do you remember that?
Lewis: Yeah ... He was Satya Nadella's predecessor. This was obviously a flop. Microsoft's smartphone
business has not done well. It has not gained market share or traction, and it's just kind
of floundered and lost money. So, in July of 2015, the company announced that they were
going to take an impairment charge of $7.5 billion related to the phone hardware business,
which is the Nokia acquisition. That was their phone hardware presence. This write-down actually
caused Microsoft to incur its largest-ever quarterly net loss.
O'Reilly: Wow.
Lewis: It's incredible. So, you see these things on the balance sheet, something like
goodwill, and it's kind of like kicking a can down the road type of approach to accounting
things. But at the end of the day, the companies have to come to terms with what they own and
what it's worth. And that's where you see these large impairment charges coming in.
This is a write down as it relates to an acquisition.
O'Reilly: Taking a step back as investors and philosophically, how does Dylan Lewis
treat a loss like that from Microsoft? What do you think when you see that?
Lewis: This was telegraphed. Investors knew what to expect, so when they had their conference
call, it was not a huge shock, which is good. That's what you want to do with a company,
you want to message it and make it clear. My personal thoughts? If you see a company
carrying a ton of goodwill, you need to be aware that this is the downside of something
like that. There's a big difference between actual value and unrealized value. And I think
that's just something to be aware of. If you're looking for a teachable moment here, you're
not always going to be able to see or really easily project how an acquisition might pan
out. But, if you see a company has a ton of goodwill on their balance sheet, maybe you
need to pump the brakes a little bit. O'Reilly: Cool. Thanks for your thoughts.
Lewis: I'm going to plug our Twitter feed briefly, Sean, just because I have to.
O'Reilly: Oh, man. You've been doing this all week. (laughs)
Lewis: I have a special trivia question for listeners. We have a little trivia tidbit
that we came across on the show, and we thought it'd be more fun to ask you guys and see if
you could find it. What is the largest goodwill write-down in history? If you know, or you
can find the answer, tweet it at us @MFIndustryFocus. We'll probably just re-tweet the first person
to find it.
Also, I want to give a special shout-out to Nagarjuna S., who correctly guessed the break-even
number of burritos at Chipotle's first location. That was something that we tweeted out earlier
that week. That was 114 burritos.
O'Reilly: Oh my gosh. Lewis: Crazy, right?
O'Reilly: What do they cost? $8 each?
Lewis: It was a long time ago. I think his monthly rent was like $850 or something.
O'Reilly: So, just to specify, the question of the day today is corporate America history,
not other write-downs too?
Lewis: Yes, I'm not accepting sovereign debt write downs.
O'Reilly: Well, I was going to be like, "The British Monarchy probably had to write-off
the 13 colonies, that would be pretty big ... " (laughs)
Lewis: No. This has happened, let's say in the last 30 years.
O'Reilly: Hint: it's a rather large number. (laughs)
Lewis: Yeah, it's huge. It makes the Microsoft Nokia acquisition look like peanuts.
O'Reilly: Yeah. Thanks again, Dylan. Lewis: Always a pleasure, Sean.
O'Reilly: See you later. That's it for us, folks. If you're a loyal listener and have
questions or comments, we would love to hear from you, just email us at IndustryFocus@Fool.com.
Again, that's IndustryFocus@Fool.com. As always, people on the program may have interests in
the stocks they talk about, and The Motley Fool may have formal recommendations for or
against those stocks, so don't buy or sell stocks based solely on what you hear. For
Dylan Lewis, I am Sean O'Reilly, thanks for listening and yadda yadda yadda.