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Discover's Goodwill Hunting


While management positioned the write down as "non-cash," the loss in value is real.

Editor's Note: The following piece was written by Minyan Peter, the author of such pieces as Digging Deeper into E*Trade and Credit Cycle Bottoms.

Yesterday Discover Financial Services (DFS) announced that it was taking a $422 mln non-cash write down of goodwill related to its February 2006 purchase of Goldfish, a UK credit card business, from Lloyds TSB (LYG). I highlight this, this morning, for several reasons:

First, the $422 mln represents all of the 32% acquisition premium paid for the assets less than two years ago.

Second, while management positioned the write down as "non-cash," the loss in value is real: It is like me saying that I bought some Cisco (CSCO) stock in 2000 for $100, kept it on my books at $100 through 2003, and then decided to take a "non-cash" write down of $80. The reality is that it was a bad investment that I should not have made.

Third, while I am not an accountant, my understanding of a goodwill write-down is that it is a recognition by management that the projected future earnings associated with a business do not support the acquisition value of those assets. Like General Motors' (GM) write down of its deferred tax assets, this charge by Discover is a forward-looking assessment of the future profitability of its UK business.

Given the significant volume of bank M&As over the past several years, I expect that Discover's announcement yesterday is just the beginning of what will be a long line of financial service "goodwill" writedowns.
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