- Were their red flags in NMC’s financial statements?
- Could the predictive models have anticipated NMC’s earnings manipulation and bankruptcy risk?
The Red Flags
NMC Aggregate Annual Purchase Considerations (US $1,000s)
| Total | 2018 | 2017 | 2016 | 2015 |
| 1,893,164 | 567,027 | 640,960 | 256,201 | 428,976 |
NMC’s Goodwill Accounting
| Average | 2018 | 2017 | 2016 | 2015 | |
| Additional goodwill (US $1,000s) | 390,329 | 471,573 | 233,906 | 345,072 | |
| Fair value of net identifiable assets (“NA,” US $1,000s) | 221,777 | 178,171 | 40,819 | 89,049 | |
| Goodwill as % of PC | 79% | 69% | 74% | 91% | 80% |
| Goodwill as % of NA | 350% | 176% | 265% | 573% | 388% |
| Goodwill on balance sheet (US $1,000s) | 1,440,291 | 1,057,765 | 567,338 | 341,420 | |
| Goodwill as % of total non-current assets | 51% | 58% | 58% | 49% | 40% |
| Goodwill as % of total assets | 30% | 37% | 36% | 24% | 23% |
| Profit after tax of acquirees for full year (US $1,000s) | 16,477 | 25,513 | 43,938 | 28,638 | |
| Profit as a % of PC | 2.9% | 3.98% | 17.15% | 6.68% |
- It is nothing but overpayment for subsidiaries. And NMC does not know why exactly it overpaid. Goodwill is a fancy way for accountants to account for this excess.
- The size of the goodwill means the overpayment might be unjustified. Hence the goodwill may soon have to be written off in full or in part. And profits will suffer massively.
- Another reason why a write-off is likely: Look at the post-tax profits of the acquiree companies as a percentage of the purchase price. It has been in steady decline since 2016, from 17% to 4% to 3%. So NMC is either desperately buying mediocre companies or paying exorbitant prices for good ones. Which is bad either way.
- But the big question: Why such obscene overpayments? Was NMC desperate to grow revenues and profits?
- The elevated goodwill could result from the deliberate undervaluation of tangible assets at the time of acquisition. Tangible assets like buildings and machines are depreciated, but goodwill never is. Given a fixed purchase consideration, undervaluing tangible assets means automatically overvaluing goodwill. If this is the case, NMC has saved millions in depreciation expenses over the years and hence overstated its net income.
- A significant proportion of the acquisitions was financed through debt. So overvalued assets were basically financed through expensive debt.
NMC’s Debt and Debt Ratios
| Adjusted | 2018 | 2017 | 2016 | 2015 | |
| Total debt (US millions) | 6,600 | 1,997 | 1,399 | 1,049 | 730 |
| Debt to equity | 4.86 | 1.5 | 1.2 | 1.1 | 1.46 |
| Debt to capital | 0.83 | 0.6 | 0.55 | 0.53 | 0.59 |
| Debt to FCF | 29 | 9 | 7 | 9 | 152 |
NMC Acquisition Financing
| 2018 | 2017 | 2016 | 2015 | |
| Financed by free cash flow | 47% | 34% | 49% | 1% |
| Financed by debt | 53% | 66% | 51% | 99% |
NMC Margins
| US Median | 2018 | 2017 | 2016 | 2015 | |
| Gross Profit Margin | 41% | 40% | 38% | 35% | |
| Operating Profit Margin | 2.5% | 18% | 17% | 15% | 13% |
| Net Profit Margin | 12% | 13% | 12% | 10% |
NMC Receivables
| 2018 | 2017 | 2016 | 2015 | |
| Receivables Past Due (US $1,000s) | 197,113 | 160,803 | 103,759 | 73,269 |
| Percentage of Above Due to Total Receivables | 31% | 31% | 28% | 26% |
Predictive Ratios
- T1 = Working Capital / Total Assets (High = positive working capital)
- T2 = Retained Earnings / Total Assets (High = profitable + less debt financing)
- T3 = Earnings Before Interest and Taxes / Total Assets (High = high operating profits)
- T4 = Market Value of Equity / Total Liabilities (High = more investor confidence)
- T5 = Sales/ Total Assets (High = more sales efficiency)
NMC Beneish M-Scores
| 2018 | 2017 | 2016 |
| -1.85 | -1.53 | -1.69 |
The Final Accounting
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