AOL Time Warner, the world's biggest media company, said on Monday that it would take a charge of $40 billion to $60 billion in the first quarter to reflect the costs of its corporate merger because of a change in accounting rules.
The charge will involve no cash outlay and will not change the company's earnings before interest, taxes, depreciation and amortization, the financial measure most watched for media companies. On paper, though, the company will post a big loss for the first quarter, perhaps among the biggest in corporate history. Though investors have readily forgiven such charges as one-time events in recent years, AOL's move will sharply reduce its total assets.
Other companies, including media giants like Viacom, are expected to take significant charges in coming months to adjust to the rule, which took effect on Jan. 1 and governs how companies account for acquisitions.
The charge by AOL, the first of its sort announced by a big company, will probably be among the biggest because the merger of AOL and Time Warner was among the biggest ever. The charge partly covers the difference between the merger's financial value and the assessed value of the companies' tangible assets, like cable lines and Internet servers.
AOL Time Warner announced the charge as part of a broader update of its financial prospects. The company lowered its overall financial forecast for 2002 and announced the long-awaited details of its $6.75 billion expansion in the European Internet market.
"The charge is a mechanical change that has no real bearing on cash or on earnings," said Tom Wolzien, a media stock analyst for Sanford Bernstein. "It doesn't mean anything for the overall health of the company."
The charge reflects the extreme overvaluation of Internet stocks at the turn of the millennium when the AOL Time Warner merger took place. It means that shareholders of both companies ended up paying too much when the companies were combined.
AOL's charge may top the record set by JDS Uniphase, a maker of telecommunications equipment, which announced in 2001 that it would write off $51 billion in costs associated with bad investments and acquisitions.
In an acquisition, the difference between the actual purchase price and the assessed value of the physical and intellectual-property assets of the target company is known as goodwill. Under the old rules, companies generally amortized the goodwill over many years, reducing earnings each quarter.
Under the new rule, companies no longer amortize but must take a charge for some or all of their remaining goodwill if it is determined that the value of the underlying asset has declined significantly, or is impaired. In the case of AOL Time Warner, America Online's acquisition of Time Warner last year created a large amount of goodwill. Now, AOL must take the charge because its stock price has declined sharply since the deal was announced in January 2000. AOL's shares opened trading in 2000 at $76, more than double its current level.
"This is a direct result of the high price that was paid in the merger," said Christopher Dixon, a media stock analyst for UBS Warburg. "This is something you're going to be seeing a lot of as companies get in line with this accounting change."
If AOL ends up charging off the full $60 billion, that would amount to almost 30 percent of the company's assets. It also would amount to almost half of the $127 billion in goodwill and other intangible assets found on AOL's books.
An accounting authority questioned the size and timing of the writedown. Jack Ciesielski, publisher of The Analyst's Accounting Observer, said: "I know there is a new set of accounting rules going forward but how could a glaring impairment of value of that size have escaped detection before this? I just can't see how it can be so obviously impaired under one methodology but you didn't know it was impaired before."
"This does not in any way reflect on our operation," said Richard D. Parsons, AOL's co-chief operating officer, who will succeed Gerald M. Levin as the company's chief executive this spring. "At the end of the day, the new rules will be good for our company because it will show the earnings power of our company unencumbered by the amortization."
In addition to the charge, AOL Time Warner said on Monday that it expected growth of 8 percent to 12 percent this year in earnings before interest, taxes, depreciation and amortization, or Ebitda. In September, the company had told Wall Street to expect "double-digit" growth. Many analysts had expected growth of at least 15 percent.