Negative shareholders equity
There have been several posts asking when negative shareholders equity is possible. Here are my two cents:
(1) LBO with dividend recapitalization Intial balance sheet: A(150) = L(100) + E(50) Increase of debt before dividend recapitalization: A(150+70) = L(100+70) + E(50) Payment of dividends, balance sheet after dividend recapitalization: A(150-70) = L(100+70) + E(50-70)
(2) Company has been consistently in red. Retained earnings hit equity balance.
(3) Accounting changes. For example, in 2006 new pension plan accounting rules were introduced requiring underfunded pension plans (previously shown off-balance) to be posted to the liabilities on the balance sheet. Intial balance sheet: A(150) = L(100) + E(50) Underfunded pension plans recorded in L: A(150) = L(100+80) + E(50-80)
(4) Severe depreciation / write-off of currency positions / assets that are required to be regularly marked-to-market / intangible assets. Intial balance sheet: A(150) = L(100) + E(50) Write-off recorded: A(150-60) = L(100) + E(50-60)
Feel free to correct me if you think there are errors.
buybacks
Sh/h equity = common stock + retained earnings + additional paid-in capital + treasuries + other comprehensive income. My understanding is that when you buyback shares, your cash balance declines, common stock decreases, treasuries increase. This situation (again as I see it) cannot result in negative equity balance.
>Could you explain how share buybacks lead to negative sh/h equity?
Look at PM that has negative equity. Equity is a just a historical record of price, and buyback makes shareholder equity negative.
Very cash generative business can keep cash on balance sheet - like APPL or like PM it can deplete old and dated price embedded in shareholder equity. SO- financial leverage neutral valuation requires adjustment and normalization of financials for such companies.
Remember that underlying assets can also appreciate above book value. Classic case is a power company or other long-standing infrastructure firm that has a bunch of assets from before the late '70s whose economic value has well-exceeded their book value.
Illinois Power builds a bunch of nuclear power plants for $500M each in the early 1970s depreciated to $200M today. Today, they are worth $3 Billion each. Illinois Power borrows $1.5 Billion against them and pays out a dividend- negative net equity of $1.3 Billion per plant, even though you really have $1.5 Billion in equity attributable to common stock.
The discrepancy between market value and book value often makes it really tough to judge balance sheets. I understand conservativism in accounting, but the truth is that when you tell me a $2 Billion transmission line is worth $100 million because you've been depreciating it for 30 years without accounting for inflation, you're not giving me any valuable information. So instead of having a 50% liability ratio, you have 120% of your balance sheet funded by liabilities and negative net equity.
I think every 10 years, the accountants need to go out and get quotes on a fire sale of all the assets. If the fire sale price is greater than the book price by 25%, we should mark the assets at 80% of the new price without recognizing a profit- sort of like currency hedge adjustments.
Are you talking about GAAP defined shareholder equity? Simple answer: yes. It's called a shareholder deficit and most of the companies that have gone into/through bankruptcy have one.
eg (pg. 132) here's a $7Bn one:
http://www.sec.gov/Archives/edgar/data/916457/000089161807000155/f27583…
Thank you everyone!
Yeah, that's kinda tough. Buybacks usually happen in mature companies. So you're going to have to eat all the way through ALL the retained earnings the company has ever gotten and then ALL contributed capital to get to negative equity. Which means that the company probably has some sort of unrecognized earnings that haven't hit the balance sheet yet if it hasn't pissed off its creditors.
60-70% of the time, the reason you have negative equity in a perfectly healthy company is that the accountants have booked a bunch of assets at historical cost less depreciation while the assets would really sell for much much more even at a fire sale in the midst of an economic panic.
You can also get negative net equity in an insolvent company that's either in or heading for bankruptcy if things don't turn around. A company isn't necessarily forced into bankruptcy until it breaches a covenant or it can't pay an obligation.
Issue $100 in equity gives you +$100 in cash. Issue $100 in debt giving you $200 in cash total. Say your share price doubled and you buy your shares back (simplified) for $150 total - then you will have negative shareholder's equity.
50=100+(-50)
I don't know if this has some holes in it, but I know from a class and a well-respected professor, that share buybacks can sometimes cause negative equity.
^^^ But (1) the bondholders will NEVER let you pay dividends or buy back stock with their liabilities unless they know the assets exceed book, and (2) a company can never buy back 100% of its stock.
Generally it's a very gradual process- at least for a healthy company. First the economic value of the assets exceeds their book value. Then the company borrows money against them- often to pick up more assets or execute a merger. Then the company just keeps paying dividends or, yes, it could do buybacks.
Thank you!
I think there's a problem in the math there:
A = L + SE 1: 150 = 100 + 50 Company takes on debt during LBO: 150+70 = (100+70) + 50 2: 220 = 170 + 50 Owner of company pays itself a cash dividiend: 3: 220 - 70 = 170 + (50 - 70) Ending Balanace: 150 = 170 - 20
Negative Shareholders Equity of Company (Originally Posted: 04/27/2013)
Since Assets=Liabilities+Shareholders Equity What would cause a company to have negative book value(share holders equity)? If a company issues debt, this increases the liabilities side as well as the asset side by the same proportion. So how can negative book value ever be the case?
Could it be that if a company reports negative earnings(net income) for a year this reduces shareholders equity by a negative retained earnings... but shouldn't the balance sheet also drop by the same amount? Under what scenario can a company have negative book value? I would appreciate any insight. Thank you!!
negative earnings would cause it, or dividends greater than earnings will drive it down
Example:
Invests $10 in business: 10 (asset) = 0 (debt) + 10 (initial invest)
Makes $5 in net income 15 (asset) = 0 (debt) + 15 (10 initial + 5 of income)
Loses $5 in net loss 10 (asset) = 0 (debt) + 10 (10 initial + 5 of income - 5 of loss)
Loses $20 in net loss, issues $20 in debt 10 (asset) = 20 (debt) - 10 (10 initial + 5 of income - 5 of loss - 20 of second loss)
Help me understand, which part is confusing?
In your last step when you issue $20 of debt. Aren't you forgetting to increase the asset by $20?
stupid purchases -> large writedowns -> suckit shareholders
Can also be due to stock buybacks
$10 - $20 (net loss) + $20 (new debt) = $10
Can a firm reject a takeover bid if the result is negative shareholders' equity? (Originally Posted: 10/19/2011)
Question on a shareholder problem... A PE firm offers $61/share for a $46/share stock, but shareholders want more, so they figure out how much debt they can obtain. They calculate $XX amount, which results in a per share stock price of $79/share.
Therefore, I would obviously say take on the leverage yourself, but if it drives shareholders' equity negative, is this possible without bankruptcy?
Remember bankruptcy is an issue of an inability to service debt or breaching its covenants, so the could have negative stockholders equity and theoretically still service debts.
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