News Corp Gets The Best Of Both Worlds
Sydney Morning Herald
Saturday July 6, 2002
Global accounting helps to smooth out the profit. Brian Robins reports.
News Corp has surrendered its position as Australia's largest public company, with its market valuation halved over the past year amid wariness over the downturn in the advertising industry and concerns that it overpaid for broadcasting rights.
And as media valuations have imploded with the collapse of the Vivendi Universal group, News Corp has not been unscathed, and is now valued at only around $52 billion, a far cry from the $100 billion-plus 12 months ago.
Vivendi Universal's near collapse has put the spotlight on the entertainment industry, and until confidence in accounting treatments revives, investors will be cautious in returning.
Since flaunting of accounting rules was at the heart of the collapse of Enron late last year, and WorldCom last week, concerns about the quality of accounts are forcing a wholesale reworking of balance sheets of major US corporations, too, as they seek to assure investors that they have not fudged their numbers by aggressive accounting assumptions.
Much of the problem in the US is with the treatment of so-called special-purpose entities, which were often created off the balance sheet, and so subject to only limited scrutiny, if at all. The same issue is a sleeper for many Australian companies, with various structures being used to get unwanted liabilities off their balance sheets.
Accounting treatment for entertainment companies is quite lax. Film production companies, for example, are able to book costs against an assumed figure for revenue, with adjustments made in subsequent years once the true numbers trickle through.
This is a wonderful device for profit smoothing and opaque to boot.
Over-optimism about the value of its film library prompted News Corp one of the biggest film production companies on Hollywood to take an $800 million write-off in 2000 on the book value of its movies, due to overconfidence in their revenue prospects.
Even after the write-off, the book value of the film inventory still rose to $3 billion last financial year.
Analysts say that within a fortnight of a film hitting theatrical release, the producer knows what domestic theatrical revenues will be and the prospective revenues from non-theatrical release, such as videos and DVDs.
Murdoch's News Corp, founded in Adelaide, is still registered and domiciled in Australia, even though it generates only about a tenth of revenues and earnings here.
So, why does it continue to call Australia home, long after Rupert Murdoch himself decided in favour of the Stars and Stripes?
A quick look at the impact of differing accounting standards between the two countries goes some way to providing an explanation. Thanks to local standards, News Corp is able to report to investors profit numbers that are significantly inflated on what they would be if it were domiciled in the US.
News Corp doesn't readily make available sets of its accounts complying with US accounting standards, but they are lodged with the Securities Exchange Commission in the US, and are available on request.
Form 20-F is the document.
In 2001, using US generally acceptable accounting practices (so-called US-GAAP), News Corp booked what it calls operating income, which what most Australian investors recognise as earnings before interest, tax, depreciation and amortisation (EBITDA) of $1.8 billion. Yet, using Australian accounting standards, that was transformed into a $3.09 billion profit a remarkable mark-up.
It is the gap between these two sets of numbers which has given analysts such as UBS Warburg's Tony Wilson cause to pause in recommending that investors take advantage of the recent sharp sell-down in News Corp shares.
On a 12-month view, for example, UBS Warburg now reckons News Corp could reach $12, well down from Wilson's earlier view that it could reach $14.50.
The stock is fair value at $10 a share, according to this analyst.
Most of the downgrade reflects declines in the value of listed associates, such as BSkyB in the UK.
``The remaining component reflects our view that until the market is fully satisfied with the quality of reported earnings, the share price is unlikely to move ahead in terms of the base valuation. To achieve this, we believe the market is likely to require a sustained period of cash from operations (before interest and tax paid) in line with reported EBITDA and a proper explanation of differences between US-GAAP and A-GAAP at the EBITDA level."
In recent years, differences in accounting treatment enabled News Corp to report a gross profit (EBITDA) typically one third higher using Australian accounting standards than if it were domiciled in the US.
This is not to suggest that News Corp has been fiddling the books, but nor is it a one-off, as this gap is now a regular feature of the group's accounts.
The gap between the two reporting regimes may help the group report a higher profit, but this makes it hard for investors to reach a true understanding of the value of News Corp shares.
``We're not saying there is anything fraudulent here," says UBS Warburg's Wilson. ``But we are saying that News was optimistic on revenue, therefore there is future risk on growing revenue prospects."
When Wilson raised the gap between the two reported profits with News Corp executives, they said it was made up of abnormals along with capitalised losses.
``Abnormals could be half the difference, and some are capitalised losses, for example Stream TV's losses," he says.
``It is not using two different methods [between US and Australian accounting practices], but it has the flexibility to run a developing business, and capitalise the losses.
``People are in fear mode, and focus on these types of things."
One of the major differences in accounting practices between the two countries is asset revaluations, along with the handling of employee entitlements.
``The Americans, until recently, prohibited the upward revaluation of assets," says Bob Walker, professor of accounting at University of NSW. This is an area where News Corp has traditionally been active.
``American accounting is tough on accrued employee entitlements, whereas we tend to have only leave and long service entitlements," says Professor Brown.
The US, too, has tougher standards on writing off intangibles, and News Corp has regularly revalued assets.
Additionally, says Ernst & Young partner Ruth Picker, the US has accounting
treatment for handling derivatives and for marking investments to market value,
where none yet exist in Australia.
MIND THE GAAP
1999 2000 2001
A-GAAP
Revenue: $21.8bn $22.4bn $25.6bn
Op profit: $2.75bn $2.74bn $3.09bn
Net profit: $1.09bn $1.92bn ($0.7bn)
US-GAAP
Revenue: $21.8bn $22.4bn $25.5bn
Op profit: $2.01bn $1.51bn $1.82bn
Net profit: $0.96bn ($0.33bn) ($0.2bn)
*All figures in $A
© 2002 Sydney Morning Herald