Fair-value accounting rule FAS 157 hasn’t delivered the volatility that some expected. But just hold on.
The rule—which was put forth by the Financial Accounting Board and went into effect at the end of last year—comes at a particularly bad time for valuations. With the economy swooning and the public markets reeling into bear market territory, companies are by and large worth less now than they were six or even three months ago.
Through July 15, the Dow Jones Industrial Average, the S&P 500 and the Nasdaq Composite Index had all fallen by at least 18% since the start of the year. Under FAS 157, that translates into a similar drop in value for many private companies. One of the main methods auditors use when applying FAS 157 is to set the values of private companies based on the valuations of their publicly traded peers.
To be sure, some companies have bucked the economic cycle and will be written up. And auditors can use a variety of other methods besides publicly traded comparables, such as looking at recent sales of similar companies, or valuing the present value of future expected cash flows.
But these, too, in general, point toward lower values, given the economic malaise and credit contraction, especially in battered sectors.
William Hupp, the CFO for funds-of-funds manager
Most buyout firms have made a habit of holding their companies at cost until some financing event, such as an exit, demands a re-valuation. General partners and their investors have so far ridden out economic troughs while experiencing few undulations in the value of their holdings.
Indeed, the recent drop in public market valuations has already been felt in some quarters. Last month,
Blackstone Group acknowledged that write-down only through clenched teeth, booking it “notwithstanding the increased profitability of the company,” according to its quarterly earning announcement. President Tony James said that FAS 157 forced his firm to “mark assets as if they’re all being sold in today’s hostile environment, despite the fact we have no intention or obligation to do so. We hold our assets for the long term and expect their value will rise as we come out of the cycle.”
Similarly, for the quarter ended March 31, Warburg Pincus swallowed a $200 million FAS 157-induced write-down on its $800 million investment in bond insurer MBIA Inc. MBIA’s stock has plummeted 75$ in 2008, including a 65% drop since April 1, to about $4.50 per share as of July 15. Warburg Pincus made two investments in MBIA about six months ago, buying into the company at just over $15 per share (taking into account warrants). Warburg Pincus declined to comment, but a source close to the firm says the write-down “doesn’t change our view of the business.”
Venture capitalists have also started to complain about FAS 157. Brad Feld, co-founder of Boulder, Colo-based venture firm
“I was at the annual meeting for one of our LPs yesterday and there was a long discussion about the impact of FAS 157 on both the buyout and the venture capital business,” Feld wrote on June 27. Once again everyone was in violent agreement that this was yet another accounting rule—promulgated by the accounting industry—to generate more fees for the accounting industry while burdening companies, especially entrepreneurial ones, with additional regulations that have no real impact on reality.”
This is an edited version of a longer piece that appears in the current issue of Buyouts.