Corporate UK's £25bn New Economy binge

This year British companies have engaged in asset write-offs to beat all records as previous overindulgences come home to roost
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The Independent Online

This year's UK company reporting season looks set to enter the record books for some of the biggest kitchen-sinking operations in living memory, with write-offs totalling at least £25bn to cover the over-investment during the late Nineties economic boom.

This year's UK company reporting season looks set to enter the record books for some of the biggest kitchen-sinking operations in living memory, with write-offs totalling at least £25bn to cover the over-investment during the late Nineties economic boom.

The excess of the boom have come back to haunt not just the telecoms, media and technology companies that were at the heart of the New Economy dash for growth, but a whole host of others that became caught up in the over indulgence of the age.

In a dash for growth, often pursued with full shareholder backing, telecoms companies invested in capacity for which, it is now clear, there could never be a market. Dot.coms poured millions into advertising to build up brands that have quickly fallen into obscurity. Media companies went on hiring sprees to expand their content while simultaneously establishing a presence in the emerging new media channels. Technology firms have been crippled by cutbacks in IT spending by big corporates that have become wary of signing off big contracts amid a continuing economic slowdown.

Analysts say some 18 per cent, or £25bn, of the FTSE All-Share's estimated £140bn earnings before interest and tax will be written off in company results covering 2001. It is not hard to see why many also see that as a conservative estimate with the mobile phone group Vodafone alone forecast to write off double-digit billions of pounds of goodwill annually over the coming years.

Most City observers expected the well-known TMTs to engage in a spot of kitchen- sinking at this time. Nevertheless, the scale of it is impressive. Psion, the handheld computer company that entered the FTSE 100 during the tech share boom, admitted 2001 was the worst in its 21-year history as it posted a £150m loss as exceptional charges hit £132m. Leaving aside the £38m that EMI paid for terminating its contract with Mariah Carey, it still expects to suffer a further £200m of one-off charges against forecast profits of £150m. Debt-ridden cable group Telewest's goodwill write-offs pushed annual reported losses to £1.93bn.

And many other companies dogged with the "troubled" tag have been taking the chance to clear the decks now. At Schroders, the fund manger, the kitchen-sinking exercise pushed it to its first loss since flotation in 1959. Kingfisher's similar effort, following the disposal of Superdrug, was dubbed by some followers of the B&Q-owner as "the longest suicide note in corporate history."

Other companies have seen this as an opportune time to rebase their dividend policy. CGNU, the insurer, is slashing the payout by 40 per cent, while analysts say Scottish Power is preparing to cut the dividend by an estimated 30 per cent.

But after the pain of all this restructuring, can shareholders look forward to earnings bouncing back during 2002? Peter Sullivan, equity strategist at the investment bank Goldman Sachs, says most analysts of the wider European stock market have seriously misjudged the situation. They are factoring in a 32 per cent rebound in earnings this year given the weak comparative that 2001 will provide. But in reality, Mr Sullivan argues, 2002 may not be that much better, since the dire corporate performances seen last year are less a one-off than a rebasing of company profits at more sensible levels.

"What's a one-off is hard to define. Our overall feeling is that analysts in general are being too optimistic about the impact and these charges aren't as one-off as they think," he says. Part of the problem is that many debt-ridden companies are much smaller businesses now, having made disposals to raise cash.

According to Goldmans, exceptional charges as a proportion of annual earnings before interest and tax have sat at between 6 and 12 per cent throughout the last decade, but leapt to 18 per cent in 2001. That contributed to an estimated 34 per cent fall in European corporate earnings in the period.

A one-third drop in exceptional charges during the current financial year – as was seen at the end of the last economic slowdown in 1994 – would add 8 per cent to corporate earnings.

Yet expectations for earnings growth in Europe this year sit at 32 per cent, falling to 21 per cent in 2003, implying company profits will exceed their previous peak in 2000 within the next three years. "In the previous two cycles, it has taken over five years for profits to reach their peak," Mr Sullivan says.

Steve Russell, equity strategist at HSBC, also has a more cautious outlook. "My inclination would be that this will not be like a normal cycle where everything suddenly bounces back. What we have had is an overstatement of profits because of the bubble," he says. While there are signs excess stocks are starting to work their way out of the system, it will not, in Mr Russell's view, be until at least the end of the year that a true investment-led recovery is underway. Indeed, in the sectors plagued most by overcapacity, notably the telecoms sector, he sees investment spending falling again this year.

Yet even if there is to be no sharp bounce back in corporate profits, there is some confidence that the valuation of the UK stock market has a solid underpinning.

Graham Secker, a strategist at Morgan Stanley, says analysts usually start the year bullish and gradually rein back forecasts as the months go by. But this year could be different. Forecasters for UK companies are today much less bullish than on the wider European sector. "We could see upgrades rather than downgrades this year," he says.

Kevin Gardiner, a strategist at Credit Suisse First Boston, agrees. "Remember, market capitalisations have fallen by far more than the value of the goodwill write-offs. Vodafone is set for write-offs for years to come, but the prospects for its share price have more to do with the outlook for average revenue [per customer]."

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