Imagine that you see a house you like. It's listed at $300,000 but you really like it. You like it so much you're willing to pay a premium to get it -- even though you know that like properties in the same area are selling for not more than $300,000.You offer $330,000. The seller is elated and your offer is accepted.

That willingness to pay a premium price is what we have seen on Wall Street for the past several years. If WonderTurtle.com has buildings and other tangible assets worth $100 million, perhaps NorthAmerican Colossal Industries (NACI) is willing to pay $250 million. The $150 million premium is regarded as "goodwill" for accounting purposes -- an "intangible" asset, but an asset nevertheless, and a positive addition to NACI's balance sheet.

It might seem as though NACI "overpaid" for WonderTurtle, but that's a difficult judgment to make. In addition to tangible assets, there is a worth to brand identifications, established business relationships, patents, client lists, a skilled workforce, and such. Maybe WonderTurtle will bring new revenues to NACI, make NACI operations more efficient, or make the formation of a strong competitor to oppose NACI more difficult.

Moreover, NACI didn't pay cash. Instead the companies exchanged stock, so NACI's "cost" to acquire WonderTurtle was just paper -- no dollars left the NACI treasury, no checks were written.

At this point you can see how a listed company with rising stock -- the mythical NACI in this case -- can acquire other companies and still not spend a dime. WonderTurtle shareholders -- an equally mythical group -- obtained a premium for their shares so they're happy. If they sell their NACI stock immediately they can pocket cash. If WonderTurtle owners keep their shares they then own a chunk of NACI.

In the real world, alas, it seems as though not all goodwill arrangements are working out as planned.

• In the past week, JDS Uniphase (JDSU - Nasdaq) reported a quarterly loss of $50.6 billion -- a record of sorts and more than the gross national product of many countries. Of the $50.6 billion lost by JDS, $44.8 billion was for goodwill.

• "In light of the adjustment of technology valuations and the current business outlook," says Nortel Networks (NT-NYSE), a huge manufacturer of communications equipment that reported of a $19.2 billion loss in the most recent quarter, the company "expects to take a charge of approximately US$12.3 billion in the second quarter to reflect the write down of intangible assets, which are primarily related to the goodwill associated with the acquisitions of Alteon WebSystems, the 980 nanometer pump-laser chip business, Xros and Qtera."

• Corning (GLW - NYSE) announced a "$4.8 billion pre-tax second-quarter charge for impairment of goodwill and other intangible assets."

• VeriSign (VRSN - Nasdaq), says the company, "reported a one time, non-cash charge in the second quarter of $9.9 billion. This non-cash charge relates to a portion of the goodwill for acquisitions made with stock over the last two years."

In some cases, at least, big premiums were paid to acquire firms with relatively few tangible assets.

As an example, according to The New York Times, Qtera had tangible assets of $33 million at the time it was acquired by Nortel. What was the value of Nortel stock used to acquire Qtera? $3 billion. (See: "Nortel Expects to Report $19 billion Loss," June 16, 2001)

But if companies are writing off vast amounts of goodwill, does that mean they're financially unstable?

Not hardly.

"You might think," says The Washington Post, "that with such a loss, JDS was about to shut its doors. Not even close. In fact, the company last year set a record for sales of its high-tech telecommunications components -- $3.2 billion. And at the end of the year, it wound up with about $365 million more than it shelled out for running its factories, offices and labs. It still has $1.8 billion in the bank, no debt and, by all accounts, good prospects as a going concern." (See: "Goodwill Hunting," July 28, 2001)

As another example, Verisign Chief Financial Officer and Executive Vice President Dana Evan says, "the acquisitions have performed at or above expectations, and on an operating basis we continue to show increased operating income, positive cash flow, and a debt free balance sheet with $1.3 billion in cash and investments."

The catch, however, is that more write-offs are likely to emerge.

"Experts," says the Post, "predict that scores of other, mostly high-tech companies will follow suit by the end of the year, with write-offs that could reach a trillion dollars or more."

In other words, "goodwill" is an "asset" as long as market premiums hold up. If premiums decline, if people and markets begin to define values differently, if business ventures don't generate anticipated benefits, then all bets are off.

But so what. Isn't this all just an accounting game? In our example, the WonderTurtle owners did well, and NACI gained $100 million in tangible assets without writing a check.

Not quite. NACI paid for the WonderTurtle acquisition with stock so shareholder equity was diluted. And if NACI paid out enough stock, then WonderTurtle sellers may have obtained a significant ownership interest in NACI.

Like last year's stock prices, much goodwill on the books may well have had great value at some point in the past. What such goodwill is worth today is likely to be a matter of ongoing debate.

For more articles by Peter G. Miller, please press here.

Published: July 31, 2001

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Peter G. Miller, also known as OurBroker®, is the author of six real estate books -- including The Common-Sense Mortgage -- and is the original creator and host of America Online's Real Estate Center. Peter's weekly columns appear in more than 100 newspapers nationwide, he is also published in a variety of other media outlets and he is a frequent speaker at national events and conventions. Peter welcomes your questions, comments, and news releases via e-mail at .