No excuse for Glencore Xstrata writedown – by Paul Murphy (Financial Times – August 23, 2013)

Argument claiming ‘accounting construct’ fails to convince

When large companies announce big asset impairment charges after a controversial takeover, as Glencore Xstrata did this week, two things happen.

First, the financial press bang the multibillion-dollar figure into a headline or two; then, almost immediately, ranks of investment banking analysts step up to explain, in condescending tones, that this is just an accounting exercise and really doesn’t matter since no cash was involved.

If the acquisition under debate involved the predator paying solely or largely in shares, as Glencore did in acquiring Xstrata, then those ignorant newspaper headlines are treated with complete disdain.

Step forward, then, Dominic O’Kane of JPMorgan Cazenove in London. As he told his clients on Wednesday: “$10.1bn of impairments/significant expenses, including a total of $8.8bn on XTA, were seized on by the press and sections of the market as evidence of the latest and perhaps most egregious example of capital misallocation in a sector with a poor recent track record. We would argue this misrepresents the true situation.”

He went on to point out that the impairments largely reflect the collapse in sector valuations between the deal closing (May 2) and the balance sheet date for the interim figures (June 30), with the FTSE 100 All Share Mining Index having fallen by about a fifth during that period – so it is “entirely [an] accounting construct”.

Mr O’Kane also noted that many of the writedowns we have seen elsewhere in the sector reflect wrong-headed takeovers and hasty projects that ate up hard cash, the implication being that the unified Glencore Xstrata, created purely by swapping shares, is no worse off.

Which is where this ‘accounting construct’ argument goes off the rails. Asset writedowns are invariably priced in by markets in advance, meaning the value destruction has happened in a very real sense – directly affecting investors, rather than management. (It should be noted in passing here that Ivan Glasenberg is Glencore’s largest shareholder as well as its chief executive.)

More to the point, fund managers tend to feel conned when big companies execute large share-funded acquisitions at points that turn out to be the peak of the cycle.

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