Nortel's "Alice in Wonderland" math

McQueen%2C%20Mark44X64.jpgPosted by Mark McQueen, CEO Wellington Financial LP]
When you ask yourself the question, “How did Nortel wind up bankrupt?” all you need to do is consider the accounting creativity of their balance sheet.
According to my morning Globe and Mail (Aug. 20), Nortel is valuing certain CDMA and LTE patents at $149 million, rather than the US$1.13 billion that Ericsson has promised to pay for a non-exclusive perpetual licence. If the Globe’s sources are in-the-know, this means that the Nortel sale doesn’t meet the federal government’s minimum deal review threshold of $312 million.
A critical question has been whether the value of the deal exceeded the $312-million (Canadian) threshold for a full-scale Investment Canada review. Nortel and Ericsson argue that the book value of the assets are only $149-million, and therefore it is not reviewable.
The government amended the Act this spring to change the threshold standard from “book value” to “enterprise value.” Enterprise value includes intellectual property and employees. But the regulations reflecting the amendments are not yet in force.
Ottawa had been vague on what standard it would apply, but a senior official said yesterday that, in the absence of new regulations, the government would use the old rules.
“With the current transaction, we’ve confirmed it will be book value” that serves as the threshold, a senior government official said yesterday.
$149 million? Who came up with that number? One scenario sounds as though officials might be considering the value of all of Nortel’s assets against all of its liabilities, but as we know, Nortel’s June balance sheet shows a negative US$4 billion of shareholder equity. So that can’t be the analysis.
Could it be that the CDMA and LTE assets are being valued at $149 million on Nortel’s current balance sheet? Quite possibly, but that’s a red herring now that the market has indicated their true value is at least US$1.13 billion.
Naturally, one can only assume that the accounting difference between $149 million and US$1.13 billion will now reside in goodwill or intangibles, or at least it should as of the date of the balance sheet that is published immediately following the Court-supervised auction. Or when the Feds ask for a new “interim” balance sheet (hint, hint).
It’s not like that difference is in thin air, and whether the difference is ascribed to the specific assets or sitting in the intangibles, it most definitely IS on the balance sheet somewhere. Or at least will be very shortly. Enterprise Value, by definition, includes debt; but the idea that book value excludes the impact of goodwill and intangibles is preposterous.
Accounting aside, it is intellectually dishonest to pretend that the patents are still worth $149 million, now that the auditors and federal officials know that someone will pay US$1.13 billion for them. Auditors aren’t fond of CFOs mis-stating the values of assets, up or down.
If the public servants advising Industry Minister Tony Clement want to encourage approval of the Ericsson LTE transaction, they are going to have to find a better cover story than this one.

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