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SCMP Reporter

Accounting rule changes mean future earnings could be adversely affected

Lenovo Group will move into negative equity as a result of its purchase of IBM's computer division, which will arrive packaged with  $14.86 billion in liabilities derived from goodwill and other intangibles.

The mainland firm will take over the loss-making  unit for a total consideration of US$1.75 billion,  including US$650 million  cash, US$600 million in  stock and the assumption of US$500 million in debt.

IBM's global  computer business  posted a negative book value of US$680.2 million at the end of June last year.

On a pro forma basis,  the enlarged company will have estimated net tangible liabilities of  $5.84 billion, as calculated for the end of September last year. Before the takeover, Lenovo's book value showed net assets of  $4.89 billion

Some analysts  were reminded of PCCW's highly leveraged takeover of Cable & Wireless HKT four years ago, which included  $172 billion in goodwill.

PCCW wrote off the goodwill in its entirety  against its reserves, producing a record negative equity figure of $14.85 billion.

Nonetheless, CSC Securities' research analyst Paul Chan Ka-wai said what was most important was whether Lenovo could maintain a strong cash flow and balance sheet after the acquisition.

Moreover, under new accounting rules introduced in 2002, Lenovo is not allowed write off the entire goodwill against its reserves, as PCCW did.

However, the goodwill could eat into Lenovo's future earnings.

The company estimates the combined company would  post a net loss of  $1.78 billion for the past financial year to March, against the  $1.95 billion net profit  Lenovo booked for the year.

The  firm explained that the hefty pro forma net losses were due partly to $630 million in goodwill amortisation charges resulting from the acquisition, assuming the deal was closed last year.

Under the previous accounting rules, companies were required to amortise goodwill through the expected life of an acquired asset, meaning that Lenovo would have had to write down about  $630 million in earnings every year.

But starting  this year, new accounting rules require  firms  to conduct impairment tests on their intangible assets and to book impairment charges against earnings if the value of intangible assets falls below that recorded in the books.

Lenovo is expected to complete the acquisition of IBM's global computer business in June.



Acquisition of IBM unit puts Lenovo into negative equity