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We posted what we think Sapura Energy is worth yesterday and eventually we wrote-off a huge lump sum on goodwill at RM7.8 billion. Many people questioned as why we did not place a value but placed a big ZERO on it.

Understanding Goodwill

Goodwill is the extra value you account for an asset which you’ve overpaid. Think of buying a property. If you bought your house at RM 1 million but the valuator comes and put only RM 800k on your house. The bank loans you RM800k for this house.

This is how your personal balance sheet is going to look like.

1. Your cash reduced by RM 200k, bank loans you RM 800k
2. Your valuator says your property is worth RM 800k
3. Plus a goodwill of RM 200k.
4. On your balance sheet, you still have RM200k in equity like before.

That’s fine!

But what if you turn bankrupt? Bank is going to re-posses your house for not paying the RM800k loan. When you can’t pay the loan, it also meant that the value of the house had declined and you can’t sell it to cover your loan. The valuation in the first place is merely RM800k and that’s problem No. 2. Basically there’s no market for your house.

The bank is going to take your house and add it into their balance sheet. Will the bank pay you back your RM200k? Think about it…

Similar Case With Sapura Energy

The oil asset had lost its appeal, with the amount of debt owing to banks being huge puts them in a tough situation. If Sapura goes bankrupt the liquidators will come in and strip things apart.

Whatever they have overpaid earlier could be written off in an instant. This is why we couldn’t put a price on intangibles and goodwill assets.

In short, a goodwill asset is an asset on paper. Goodwill asset have yet to realized until the point that the physical asset that it ties down to gets sold.

Taking into account the oil and gas sector had been in a mess with smaller companies going bust like Perisai Petroleum. The supply of oil and gas assets are at plenty. Why would one buy those assets at a higher price?

If oil price is $200 a barrel today we wouldn’t even have this discussion, Sapura Energy would have brighten up their books by slowly writing off goodwill as an expense and allocate more room for goodwill towards acquiring better assets.