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Comment by foepys | Hacker News Reader

How can a company that is valued at $16.6 billion with $19 billion in debt buy a company that is valued at $19.4 billion with $11 billion in debt for $34 billion? From where is the money for such acquisitions coming?

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I think you're confused about "value."

CTL isn't valued at $16B. That's only the market capitalization of its common shares outstanding.

  LVLT market cap = $19.4B
  LVLT assets = $24.1B (as of FYE15)

  CTL market cap = $16.5B
  CTL assets = $47.6B (as of FYE15)

This deal's ~$10B cash + ~$15B stock (edit: based on diff. article from wsj[0] It's $34B if you include $10B in LT debt.) CTL needs to raise cash and issue/buy-back shares. Lots of options, but I'm sure they already have creditors lined up.

On an unrelated note, CTL has $20B in goodwill on its balance sheet. Wow...

edit: [0] http://on.wsj.com/2f0DDdj

I never quite understood how goodwill is calculated. I mean, I can understand how ATVI (Activision) or HAS (Hasbro) can have big "goodwill". But it doesn't make sense for CTL. Do you have any explanation?

I think of goodwill as the premium you pay over the book value of an asset. It sounds like CTL will take on some goodwill in this deal. Likely, CTL views LVLT as having intangibles -- e.g. strategic regulatory relationships, exclusive fiber contracts, employee culture, etc.

It's simply the difference between the money you have paid when acquiring other companies and the value of the business you were acquiring from an accounting point of view (including tangible assets and also intangible assets that can be identified and valued).

It's BS assets that companies use to add phantom value to a balance sheet with things like "brand value" and "intellectual capital". There's no way to assess an actual value, so a lot of companies give outlandish valuations to themselves to make themselves appear more valuable than they are. Some people will disagree with that, but that's the reality.

There are of course a lot of companies that have extremely valuable brands and IP, but those tend to trade at pretty fair market valuations and don't have an unusually high percentage of goodwill relative to the rest of their assets.

In the case of CenturyLink, that would be a major red flag to me.

Goodwill is just accounting. It is your what you pay - net assets whats on their balance sheets. No real BS about that.

Right, but just because an accounting team says "Well yeah the market values the company at $5B, but we think it's worth $15B because goodwill" does not make it so.

In some cases, there is additional value created by an acquisition that can justify that added value, but in many cases it's just a way to justify an irrational overvaluation on a balance sheet.

For example, the last time I looked CTL had lost about $2 billion in market cap after this deal was announced. That's the market saying "you overpaid for this company" or, as I prefer to say "your goodwill valuation is BS."

It doesn't work like that. You're not paying $15bn for some assets worth $5bn because you have decided that the "goodwill" is $10bn. It's the other way around: you have decided to pay $15bn and as a result you write down in your books tangible and intangible assets for $5bn and "goodwill" (the balance) for $10bn. Maybe you think it's better to write off the $10bn as wasted money right away, but that also creates some issues (for example, you would probably wipe off your profits for several years, so you wouldn't have to pay taxes).

Goodwill is the amount you paid beyond the tangible assets (cash, property, equipment, accounts paid, etc.) on the balance sheet. You can call it what you like, but basically it's something you spent cash on that you have to show on a balance sheet but has no tangible value. This is usually attributed as "synergies", "IP", "brand recognition" and other BS.

> Goodwill is the amount you paid beyond the tangible assets

Wrong. For example "Hewlett-Packard purchased Autonomy for $11 billion in 2011. The purchase price represented a greater than 65 percent premium over the price at which Autonomy was trading at the time of the announcement. Hewlett-Packard recorded $6.9 billion of goodwill and $4.3 billion of other intangible assets in connection with the acquisition."

Ha and how'd that work for them? According to the Wikipedia entry, "within a year HP had written off $8.8 billion of the value."

Thanks for helping me make my point.

You're welcome. Just to be clear, I agree that paying too much when making acquisitions is not a good business model. But goodwill is not the reason for overpaying, or an excuse for overpaying. Goodwill is the consequence of overpaying.

Assume that Qwest invests $1B in copper wire, telephone poles and central offices in 1970. The accountants write that off over the next X years because, for accounting and tax purposes its getting old and will need to be replaced. In the year 2000 all that copper and those poles have zero value on the books (called book value) but it's obvious that it still has some value.

Century Link comes along and looks at the value of all the copper in the ground and says that they will pay $1B for it even though on the books it has zero book value. That excess paid becomes good will on Century Link because they paid more for it than book value.

"Goodwill" is simply an accounting term (remove any preconceptions of what "goodwill" actually is).

Goodwill is essentially what happens when you pay over book value for an asset.

It's quite common in telecom, because telecom infrastructure investments are generally depreciated over 10 years, but the capital assets still have some value even after they've been depreciated for tax purposes. If they were still listed as capital assets they could be depreciated, so they have to be booked as an asset somewhere.

I think others have done a good job explaining this, so all I'll add is: accounting is an entirely different exercise than valuation. Which seems strange... But the goal of accounting is tracking assets and accounts more so than understanding value.

>"CTL needs to raise cash and issue/buy-back shares."

Can you elaborate on this? Does CTL need to buy back shares so that they can use them to put towards the $15B in stock to put towards the LVLT transaction?

If this is so isn't this the equivalent of cash? Since they need to finance that purchase of stock? How would that not be $10B plus $15B?

If the source of that financing is creditors how do they get paid if not cash? Is this some kind of structured financing?

Basically the company gets bigger when they add Level 3 to it so they can issue additional shares without diluting their current outstanding shares.

Think of it more as converting your Level 3 stock into Century Link stock.

Not sure exactly how they'll do it.

The $10B in cash is the $25/share * # of LVLT shares. CTL has to come up with that. It looks like they have $10B in lending ready to go from MS and BAML.

For the stock, CTL can do a lot of things but just need to come up with the shares at the agreed upon conversion factor. Likely, CTL will issue new shares. Current CTL shareholders will hope that the dilutive effects will be offset by the accretive gains from owning a smaller chunk of a bigger company. Alternatively, CTL could use cash on hand (or from asset sales), treasury stock, and more to purchase shares to then hand over. I don't know CTL's plans.

Ignorant question: If I manage to buy all outstanding shares, do I not own the underlying assets? If so, why are the assets valued separately from the shares?

Market capitalization is the value of all the public shares, and is determined by investor sentiment about the medium/long-term prospects of the company as much as any other factor. The underlying assets are wholly owned by the company and have an intrinsic value that is easier to measure through accounting, but that alone doesn't take in to account the liabilities or debts on the books.

Shares are a form of equity. Owning the shares will give you a claim to the residual assets of the company after all the liabilities have been settled. So what you own is effectively the 'Net Assets' of the company. This is different from outright owning the actual underlying assets of the company.

To slightly complicate things, the total assets shown on the annual report of these companies are mostly on their cost basis. During an acquisition like this, they would be 'fair valued', which could result in significant write up or write off compared to the cost basis.

They also just recently laid off 3000 employees due to a "loss of $600 million a year"...

http://finance.yahoo.com/news/centurylink-lay-off-3-000-1305...

Okie Dokie

That's precisely why this acquisition is happening now, they're not doing so well and that means they are (relatively) cheap.

Level 3 is doing phenomenal. I think you have this the other way around.

That would true if L3 was acquiring Century Link, but Century is acquiring L3.

From the OPs article link:

"In a memo issued to employees Wednesday, CenturyLink CEO Glenn Post said that sinking legacy revenue has resulted in a loss of $600 million a year for the company."

Ah, silly me! I thought there was something weird about L3 buying them but in a way it's even weirder to see it happen the other way around. Thanks for the correction.

As another poster mentioned, in this case the asset values of the acquirer are bigger.

But smaller companies buy bigger companies even without that. In general they just need somebody to fund the acquisition either through debt (they borrow the money) or equity (they issue more stock). Generally it has to be done with debt. The reason it can work in telecom is that business tends to be very recurring revenue so people are willing to lend them money. (Their recurring revenue looks like a bond) An investor can see that two companies have similar businesses and economies of scale, and they want the more efficiently run one to be the acquirer, even if it's the smaller one.

I am no expert but I will try.

First, there is no strict separation between acquisitions and mergers. It is often somewhere in between.

If CenturyLink is valued at $16.6 billion with $19 billion in debt, that means the company without debt would be worth $35.6 billion. Likewise Level 3 without debt would be worth 19.4 + 11 = $30.4 billion.

The article says that "the value of the deal includes assumed debt", so they are really just paying 34-11= $23 billion for the Level 3 stock (I think).

It also says they are getting $10.2 billion in new debt, meaning they are issuing ~$13 billion worth of new CenturyLink stock, and giving that to current Level 3 shareholders.

If I calculated things right, CenturyLink shareholders will own about 56% of shares in the combined company, with Level 3 shareholders getting 44% plus some cash. The combined company will be worth about $26 billion, and have about $40 billion of debt, so the banks will wield quite a lot of power.

I'm not a finance guy, but isn't that just econ 101?

Your company is valued at X, you take on Y in loan and invest some of that into, e.g., buying and laying fiber. Your company will now be valued at X+f*Y, where f is some adjustment factor. E.g. you may not get the same money back if you sold the fiber today. On the other hand, that fiber is projected to earn you some money over time.

I do agree those are huge figures, but it could make sense.

The acquirer issues new shares and gives them to the acquiree's shareholders in exchange for their stake.

In this case, the acquirer also buys out the acquiree's debt. This part of the deal is funded by a loan from Bank of America and Morgan Stanley.

More debt?

The real secret to making money seems to be making more money (debt).

I am starting to think fractional reserve banking was a bad idea

If only it were that simple. Turns out that, rather than being constrained by the deposits/assets they have on hand (FRB doctrine), banks will create the loans they believe they can make, then go settle up with the central bank/regulators. See, for example, (unorthodox) economist Steve Keen [0][1] on this.

[0] http://www.forbes.com/sites/stevekeen/2015/02/28/what-is-mon...

[1] https://en.wikipedia.org/wiki/Steve_Keen

Yeah, that was my greatest take away from what I've read from him. Talk about the tail wagging the dog.

The restrictions in this light almost do more harm than good since it exonerates the banks (or rather the system) and every time we have a crisis (after people have been making the big bucks for years) we treat it as mysterious and unrelated to the profits made in the 'good' times.

One of the primary responses to the 2008 crisis has been to change the regulations around capital requirements for banks and other financial institutions.

https://en.wikipedia.org/wiki/Basel_III

Note that even though the introduction calls it a voluntary framework, the US and EU have implemented much of it in their regulatory systems.

It's not just fractional reserve that's the issue. Even metalists et. al. miss the fundamental issue that debt is simply a means of control. You put someone into debt to make them slaves. Debt is also the product of war. It's been toned down in the modern western world with mergers and acquisitions, but deep down it's all the same.

Read: Debt The First 5,000 Years. It's a life changing book that helps all this stuff make a lot more sense.

While I agree, you don't need formal fractional reserve banking to create the same sorts of crises, see for example the various US financial panics prior to the creation of the Fed in 1913 (e.g. go to the bottom of https://en.wikipedia.org/wiki/Panic_of_1910%E2%80%9311 and hit Show on "Banking panics in the United States").

how else would they acquire Frontier, Windstream, Bresnan, Matrix, UBTA-UBET? with cash?

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