Ford has just announced a likely major write-up to it's balance sheet, according to Automotive News. It is reversing an impairment charge against its deferred tax-assets that could see its profit increase by several billion dollars - possibly as much as $13 billion.
Deferred tax assets are a financial accounting phenomenon that arise from the fact that sometimes companies pay taxes on a different schedule from that which is used in their public financial statements. This can happen when for instance, financial depreciation and tax depreciation differ. It also happens when a company experiences a big loss for which it earns a tax-loss carryforward. This is a real benefit, because it means that future earnings will be tax free (on a cash basis). The company can book the difference as an asset, which can then be applied against income tax provisions.
The problem is, tax loss carry forwards are a wasting asset - they have to be used up within 20 years. If a company has really large loss carryforwards (GM at one point had $39bn), and uncertain profitability, it may have to impair those assets, which, like any writeoff count as a loss.
Ford, however, is now making some good money and even after losing $31.5bn is now looking to earn enough going forward to actually claim the benefit. Thus, it is looking at reversing much of it $15.7bn valuation allowance. This is an incredibly positive sign for the company and a very strong statement about management's future expectations for profitability.
Such a large write up would raise retained earnings above a deficit level and eliminate the overall shareholder's deficit as well. While this would not reduce the nominal value of the debt, it would improve Ford's debt/equity ratio, and improve its crediworthiness and potentially enable the firm to cut borrowing costs through refinancing. (The cash outlay for taxes that it does not pay also provide Ford with extra resources to reduce the nominal value of outstanding debt.
About 10 years ago, I predicted that Ford and General Motors would be bankrupt (I believed that Daimler would hold on to Chrysler and would scrape by). I was of course, wrong.
Not entirely wrong, but I was wrong. Ford, which I believed would crater first, dragging GM with it, has instead managed to survive without a bankruptcy (though also without most of its brands, which included Volvo, Mazda, Aston Martin, Jaguar, Land Rover and Mercury).
It turns out that I was really wrong about my central premise: that Ford, with a two-tiered equity structure, had a weaker capital structure and would therefore reach illiquidity first. It's share of the car market was declining precipitously, in absolute terms about as fast as GM, but GM's share of the market was larger, so relative to size, Ford was imploding. Moreover, I assumed that the only shot the companies had to avoid bankruptcy was a major equity raise, which with Ford's special B class shares, seemed unlikely.
It turns out, Ford had just enough assets against which it could secure financing to avoid that capital raise (lucky for Ford, underwriting standards and interest rates were incredibly favorable to heavily indebted, risky credits). GM, likely the firm with poorer management (though both firms had questionable managements), collapsed instead.
My second error was to believe that the bankruptcy of one would pull down the other, since they competed heavily for the same customers, and the cost advantages of the bankrupt firm would allow it to purchase market share at the expense of the other. This has also turned out not to be true. In part, this is because of the structure of the bankruptcy, which has maintained labor cost parity between the firms. In part, it is because angry consumers are rewarding Ford for avoiding a direct government bailout (the preservation of the supplier network was a major, if indirect, help to Ford. Production disruptions, which were highly probable, would have cratered the firm's cash and brought on bankruptcy and possibly liquidation).
Ford's shares, which hovered near $1 for quite some time, are now at $15. Many questions remain - can Ford revive Lincoln? What happens to Ford's franchise in light trucks if gas prices rise above $5. Can it straighten out its overseas arms, which are large, but need operational reforms?
I wish Alan Mullaly and his team well.
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