So what causes a goodwill impairment?
A goodwill impairment is the result of a bad investment.
With AOL TimeWarner, there was a failure to see that AOL had no long-term competitive advantage and that its stock price was therefore inflated5. But before we go further, let’s summarize the basics of goodwill impairments:
- Goodwill is only recognized when a company acquires another firm by paying more than the fair value of the target firm’s net assets.
- If the fair value of the target firm ever falls below the carrying value of the target firm, you could have a goodwill impairment.
Take the company Oath, which is the combined company created after Verizon purchased Yahoo and AOL. The fair value of Yahoo and AOL’s net assets was $4.5 billion at the time of the acquisitions, so Verizon recorded the remaining amount of the purchase price as goodwill6. But Verizon soon learned that Oath simply couldn’t compete with Google and Facebook in the digital ad space7.
As a publicly-traded company, Verizon is required to test its goodwill for impairment annually. Oath’s declining revenue8 suggested that Oath’s fair value was much lower than its carrying value (the $9 billion Verizon had paid), so Verizon wrote off all of its goodwill – taking a $4.5 billion hit to its earnings9. In this case, the goodwill impairment could be traced back to a poor business decision: Verizon should never have paid $9 billion for two internet companies that were on the decline.