Session 24: Intangibles - Notes
Intangibles
Mini Case 3
- Read the case and finish “Mini Case 3 Quiz” by Tuesday, May 6 at 10 PM.
- The questions are based on the case materials.
- There are five multiple-choice questions, and you have 20 minutes to complete the quiz.
- You only have one attempt.
- You may refer to the case while answering questions.
Intangibles
- Basics
- Patent
- Trademark
- R&D
- Goodwill (LN6)
- M&A Basics
- Accounting for goodwill
- In-class exercise: Facebook’s acquisition of WhatsApp
M&A Basics
Merger
A merger describes two firms joining forces to move forward as a single new entity.
- When Daimler-Benz and Chrysler merged in 1998, both companies ceased to exist, and a new company, DaimlerChrysler, was created.
- Both companies' stocks were surrendered, and new company stock was issued in its place.
Acquisition
An acquisition describes one company purchasing most or all of another company's shares to gain control of that company.
- e.g., Facebook acquired WhatsApp in 2014.
Method of Payment
Cash
- The acquirer can pay cash for all the equity shares of the target company.
- Pay each shareholder of the target company a specified amount for each share.
Equity (stock)
- The acquirer can issue and provide its own shares to the target company's shareholders.
- Essentially, shareholders of the target trade their shares for shares in the acquirer.
Goodwill (LN6 p.2)
- Goodwill only exists when one company (acquirer) acquires another company (target).
- Represents the excess of the purchase price over the fair value of identifiable net assets of the target company.
- Goodwill = Purchase price – FV of identifiable net assets of the target
Goodwill = Purchase price – FV of identifiable net assets of the target
- Essentially, it’s the amount of premium you pay when you buy a company.
- Question: Why would an acquirer be willing to pay a premium?
- Future growth potential
- Synergies
- Intangibles
- How much the target company is worth
Goodwill (LN6 p.2)
Note that…
- Recorded on the acquirer’s book.
- Cannot be separated from the business as a whole.
- “Indefinite-life” intangible asset \Rightarrow No amortization of goodwill.
Accounting for Goodwill (LN6 p.3)
Example: ABC Corp. pays $160k in cash to acquire XYZ Corp., whose book value of equity is $20k and whose books reflect the following balances:
XYZ’s balance sheet before being acquired (book value of assets and liabilities)
| Current Assets | 50 |
| Fixed Assets | 140 |
| Stockholders’ Equity | 20 |
| Current Liabilities | 40 |
| Long-Term Liabilities | 130 |
ABC (Acquirer): How to account for this transaction?
Accounting for Goodwill (LN6 p.3)
XYZ’s fair value of assets and liabilities
- Determine the fair value of all identifiable (including tangible and intangible) assets and liabilities of the target company.
Suppose these values are:
| Current Assets | 50 |
| Fixed Assets | 200 |
| Patent | 30 |
| Current Liabilities | 40 |
| Long-term Liabilities | 140 |
- Fair value of identifiable net assets: Fair Value of Assets – Fair Value of Liabilities
(50 + 200 + 30) – (40 + 140) = 100 - Compute goodwill as the “left-over” value:
Goodwill = Acquisition price - Fair value net assets acquired = 160 – 100 = 60
- How much the target company is worth
- Only assets and liabilities, ignore SE
Accounting for Goodwill (LN6 p.3)
XYZ’s fair value of assets and liabilities
All assets and liabilities acquired must be recognized at their fair value.
| Current Assets | 50 |
| Fixed Assets | 200 |
| Patent | 30 |
| Current Liabilities | 40 |
| Long-term Liabilities | 140 |
ABC’s journal entry (acquiring company) to record the acquisition:
Three steps
- Record all the acquired assets and liabilities from the target at fair value.
- Record goodwill.
- Record either cash (-A) or shares (+SE) to pay for the transaction.
| | | |
| :------------------- | :- | :- |
| Current Asset (+A) | 50| |
| Fixed Assets (+A) | 200| |
| Patent (+A) | 30| |
| Goodwill (+A) | 60| |
| Current Liabilities (+L)| | 40|
| Long-term Liabilities (+L)| | 140|
| Cash (-A) | | 160|
Accounting for Goodwill
- Suppose ABC (the acquiring company) had the following B/S prior to the acquisition:
| Cash | 200 |
| Current Assets | 100 |
| Fixed Assets | 100 |
| Total Assets | 400 |
| Current Liabilities | 30 |
| Long-Term Liabilities | 70 |
| Shareholders’ Equity | 300 |
| Total Liabilities and Equities | 400 |
- Then ABC’s post-acquisition B/S would be:
| Cash | 200 – 160 |
| Current Assets | 100 + 50 |
| Fixed Assets | 100 + 200 |
| Patent | 30 |
| Goodwill | 60 |
| Total Assets | 580 |
| Current Liabilities | 30 + 40 |
| Long-Term Liabilities | 70 + 140 |
| Shareholders’ Equity | 300 |
| Total Liabilities and Equities | 580 |
How does Goodwill get on the books?
Total goodwill on the books of S&P 500 companies
$3 trillion
- Graph showing an increase in total goodwill on the books of S&P 500 companies from 2013 to 2019.
Facebook’s Acquisition of WhatsApp
- In 2014, Facebook acquired 100% of WhatsApp shares for $17 billion.
- The acquisition price was indicative of a market value for WhatsApp.
- Exceed American Airlines, Ralph Lauren, and Coach
- As another point of reference
- Facebook bought Instagram for $1 billion
- Microsoft bought Skype for $8.5 billion
- Yahoo! Bought Tumblr for $1.1 billion
Facebook’s Acquisition of WhatsApp
- A tiny startup with 55 employees
- $50 million of total assets (far less than the purchase price!)
- It was unprofitable
- But it grew rapidly
- 450 million monthly users
- 1 million new users signing on per day
- 70% users are active daily
- Handle 19 billion messages per day, including 600m photos
In-class Exercise:
Facebook's Acquisition of WhatsApp (LN6 p.4)
Note 2: Acquisitions
Goodwill generated from the WhatsApp acquisition is primarily attributable to expected synergies from future growth, from potential monetization opportunities, from strategic advantages provided in the mobile ecosystem, and from the expansion of mobile messaging offerings.
Simplified acquisition journal entry
| Intangible assets (+A) | 2,783 |
| Goodwill (+A) | 15,342 |
| Liabilities (+L) | 33 |
| Deferred tax liabilities (+L) | 899 |
Note 2: Acquisitions
| Intangible assets (+A) | 2,783 |
| Goodwill (+A) | 15,342 |
| Liabilities (+L) | 33 |
| Deferred tax liabilities (+L) | 899 |
| Cash (-A) | 4,589 |
| Common stock (+SE) | 12,604 |
- Plug number: 17,193 – 4,589
Assume that, in addition to the cash payment, the balance is settled by issuing common stock.
WhatsApp in 2013: Income Statement (p.7)
STATEMENT OF OPERATIONS (in thousands)
| 2013 | 2012 | |
|---|---|---|
| Revenue | $10,210 | $3,821 |
| Cost of revenue | 52,867 | |
| Research and development | 18,858 | |
| General and administrative | 76,911 | |
| Sales and marketing | 34,487 | |
| Total costs and expenses | 148,678 | 59,397 |
| Loss from operations | (138,468) | (55,576) |
| Other income (expense), net | (264) | 8 |
| Loss before benefit from income taxes | (138,732) | (55,568) |
| Benefit from income taxes | 586 | 899 |
| Net loss | $(138,146) | $(54,669) |
WhatsApp in 2013: SCF (p.8)
STATEMENTS OF CASH FLOWS (in thousands)
| 2013 | 2012 | |
|---|---|---|
| Net loss | $(138,146) | $(54,669) |
| Adjustments to reconcile net loss to net cash used in operating activities: | ||
| Depreciation and amortization | 71 | 61 |
| Share-based compensation expense | 98,805 | 38,259 |
| Changes in operating assets and liabilities: | ||
| Accounts receivable | 2,159 | (819) |
| Prepaid expenses and other current assets | (1,884) | (166) |
| Other assets | 817 | (985) |
| Accounts payable | 2,858 | 712 |
| Accrued liabilities and other current liabilities | 5,366 | 92 |
| Deferred revenue | 20,014 | 14,016 |
| Net cash used in operating activities | (9,940) | (3,499) |
| Cash flows from investing activities: | ||
| Changes to restricted cash | (1,800) | |
| Purchase of property and equipment | (166) | (119) |
| Net cash used in investing activities | (1,966) | (119) |
| Cash flows from financing activities: | ||
| Proceeds from issuance of redeemable convertible preferred stock | 49,802 | |
| Proceeds from exercise of stock options | 1,088 | 82 |
| Net cash provided by financing activities | 50,890 | 82 |
| Net increase (decrease) in cash | 38,984 | (3,536) |
| Cash, beginning of period | 6,558 | 10,094 |
| Cash, end of period | $45,542 | $6,558 |
WhatsApp, Inc. 2013 Financial Statements (excerpts)
BALANCE SHEETS (in thousands, except for number of shares and par value)
| 2013 | 2012 | |
|---|---|---|
| Assets | ||
| Current assets: | ||
| Cash | $45,542 | $6,558 |
| Accounts receivable | 2 | 2,161 |
| Prepaid expenses and other current assets | 2,866 | 933 |
| Total current assets | 48,410 | 9,652 |
| Restricted cash | 1,800 | |
| Property and equipment, net | 281 | 186 |
| Other assets | 295 | 1,112 |
| Total assets | $50,786 | $10,950 |
| Liabilities, redeemable convertible preferred stock, and stockholders' deficit | ||
| Current liabilities: | ||
| Deferred revenue, current portion | 3,983 | 1,125 |
| Total current liabilities | 5,810 | 332 |
| Early exercise liabilities, non-current portion | 43 | |
| Deferred revenue, non-current portion | 16,247 | 5,119 |
| Total liabilities | 26,588 | 6,722 |
| Redeemable convertible preferred stock | 60,049 | 31,008 |
| Stockholders' deficit | (429,544) | |
| Total liabilities, redeemable convertible preferred stock, and stockholders' deficit | $50,786 | $10,950 |
Why Facebook paid $17b?
Synergies!
- Graph showing that:
- Total Liabilities = 26,588
- Redeemable convertible preferred stock = 60,049
What did Facebook get for $17b?
… expected to provide us with strategic advantages in the mobile ecosystem and expand our mobile messaging offering. …
- Expand into overseas markets
- Attract a younger audience
- Strengthen mobile presence
- Block competitors like Google from acquiring it
Facebook Inc. 2014 10-K Financial Statements (excerpts)
CONSOLIDATED BALANCE SHEETS (in millions, except for number of shares and par value)
| 2014 | 2013 | |
|---|---|---|
| Assets | ||
| Current assets: | ||
| Cash and cash equivalents | $4,315 | $3,323 |
| Marketable securities | 6,884 | 8,126 |
| Accounts receivable, net | 1,678 | 1,109 |
| Prepaid expenses and other current assets | 793 | 512 |
| Total current assets | 13,670 | 13,070 |
| Property and equipment, net | 3,967 | 2,882 |
| Intangible assets, net | 3,929 | 883 |
| Goodwill | 17,981 | 839 |
| Other assets | 839 | 637 |
| Total assets | $40,184 | $17,895 |
Cash flows from investing activities:
| Purchases of property and equipment | (1,831) | (1,362) | (1,235) |
| Purchases of marketable securities | (1,362) | (9,104) | (7,433) |
| Sales of marketable securities | (9,104) | 2,988 | 2,100 |
| Maturities of marketable securities | 2,988 | 3,563 | 3,333 |
| Acquisitions of businesses, net of cash acquired | 3,563 | (368) | (911) |
| Change in restricted cash and deposits | (368) | (11) | (2) |
| Other investing activities, net | (11) | (1) | (2) |
| Net cash used in investing activities | (1) | (2,624) | (7,024) |