Valuation & Litigation Advisory Blog

On the verge of a summer that could determine the fate of not only the Cavs, but Cleveland sports as a whole, for the next decade (or century depending on how jaded your viewpoint has become), I cannot help but think that I would not want to be Cavs owner Dan Gilbert right now. LeBron James’ impending free agency will be the talk of the summer, and his decision regarding where he wants to spend the next few years playing basketball will go a long way in determining whether Gilbert’s significant investment in the Cavs goes boom or bust. Oddly enough, this situation parallels a few of the more pertinent issues in intangible asset impairment testing which, although not quite as exciting as watching LeBron “throw the hammer down,” probably impacts you more from a business perspective (unless you happen to own “The Q” or a sports bar in downtown Cleveland). 

If LeBron decides to stay (which may spur a gale force collective exhale from Northeast Ohio), the cash registers will keep singing for Mr. Gilbert and his investment in the Cavs will be safe for the time being. On the other hand, if LeBron bails on his hometown and heads for New York, New Jersey, Chicago, or any of the other cities pining for him, the Cavs may become about as valuable as the sixth grade CYO team at All Saints. A player like LeBron, who pretty much has an all or nothing effect on the value of the Cavs franchise, is very similar to the major customer of any company with intangible assets on its books.

The rules for intangible asset impairment testing (for intangibles other than goodwill) allow for a company to compare the undiscounted future cash flows associated with an intangible asset to the asset’s net carrying value on the balance sheet. If the future undiscounted cash flows are greater than the net carrying value of the asset (which is most often the case), then there is no impairment. If the future undiscounted cash flows are less than the net carrying value of the asset, however, then impairment exists and those future cash flows are discounted back to the present day to determine the new fair value of the asset. Because intangible assets other than goodwill are amortized, they decrease in value on a company’s balance sheet each year. Therefore, the standards allow companies to consider the undiscounted future cash flows associated with these intangibles in testing whether they are impaired, which makes it much more difficult to fail than if the actual fair values of the intangibles were determined (using discounted cash flows). 

For example, if LeBron stays with the Cavs and Shaq does not return next year, it is not all that big of a blow to the team. This would be the equivalent of losing a decent customer, but not your largest. More often than not, losing a low to moderate volume customer (and the future cash flows that were expected to be generated from that customer) will not result in the impairment of a company’s intangible assets. 

If the Cavs were to lose LeBron, however, it may send the franchise back to the days of Shawn Kemp, “splash” jerseys, and shooting at the wrong hoop on purpose. You could equate this to losing your biggest customer – one that accounts for more than half of your revenue and profits. While the benefits (and expected future cash flows) generated from this type of customer are outstanding while you have them, their departure can be crippling and more often than not equate to intangible asset impairment, as well.

What about if the Cavs keep LeBron, they do not resign Shaq, Anderson Varejao decides to play in Brazil, and Delonte West goes to jail? In this case, the picture isn’t quite as clear cut. Losing a handful of low to moderate volume customers can sometimes spell impairment, but not always. The potential for impairment is present, but just how much (if any), would be determined by crunching the numbers.

As discussed above, there are certain situations in which intangible asset impairment is likely present, or vice versa. Other times, the picture is not quite as clear. Regardless of the situation, each year companies must perform an impairment analysis of their amortizable intangible assets to determine whether or not the future cash flows expected to be generated from each intangible are greater than the assets’ net carrying values.

For us Clevelanders, all we can do is pray that LeBron stays loyal to his hometown and does not impair our city (or Dan Gilbert’s investment in the Cavs) from its best chance to break its 46-year championship drought.