Ebix's Troubling Intangibles

Ebix (Nasdaq: EBIX  ) carries $333.3 million of goodwill and other intangibles on its balance sheet. Sometimes goodwill, especially when it's excessive, can foreshadow problems down the road. Could this be the case with Ebix?

Before we answer that, let's look at what could go wrong.

AOL blows up
In early 2002, AOL Time Warner was trading for $66.27 per share.

It had $209 billion of assets on its balance sheet, and $128 billion of that was in the form of goodwill and other intangible assets. Goodwill is simply the difference between the price paid for a company during an acquisition and the net assets of the acquired company. The $128 billion of goodwill in this case was created when AOL and Time Warner merged in 2000.

The problem with inflating your net assets with goodwill is that it can -- being intangible after all -- go away if the acquisition or merger doesn't create the amount of value that was expected. That's what happened in AOL Time Warner's case. It had to write off most of the goodwill over the next few months, and one year later that line item had shrunk to $37 billion. Investors punished the stock along the way, sending it down to $27.04 -- or nearly a 60% loss.

In his fine book It's Earnings That Count, Hewitt Heiserman explains the AOL situation and how two simple metrics can help minimize your risk of owning a company that may blow up like this. Let's see how Ebix holds up using his two metrics.

Intangible assets ratio
This ratio shows us the percentage of total assets made up by goodwill and other intangibles. Heiserman says he views anything over 20% as worrisome, "because management might be overpaying for the acquisition or acquisitions that gave rise to the goodwill."

Ebix has an intangible assets ratio of 78%.

This is well above Heiserman's threshold, and you should keep a close eye on just how the company is fueling its growth. It's also useful to compare it to tangible book value, which I explain below.

Tangible book value
Tangible book value is simply what remains after subtracting goodwill and other intangibles from shareholders' equity. If this is not a positive value, Heiserman advises you to run away because such companies may "lack the balance sheet muscle to protect themselves in a recession or from better-financed competitors."

Ebix's tangible book value is $2.0 million, so no yellow flag here.

Foolish bottom line
If you own Ebix, or any other company that fails one of these checks, make sure you understand the business model and management's objectives. You can never base an entire investment thesis on one or two metrics, but there is a yellow flag here. I'll help you keep a close eye on these ratios over the next few quarters by updating them soon after each earnings report.

Keep up with Ebix, including news and analysis as it's published, by adding the company to your free, personalized watchlist.

Rex Moore owns none of the companies mentioned in this article. The Motley Fool owns shares of Ebix. Motley Fool newsletter services have recommended buying shares of Ebix. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (5) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 09, 2012, at 9:00 PM, EricLin wrote:

    Intangibles are high, but this is a software company we are talking about. Their real assets are in IP and brainpower, all of which is not reflected on the balance sheet. When looking at intangibles you also need to look at cashflow and earnings. In AOL's case, the cashflow and earnings were not there, but in EBIX case we are talking about a company trading at roughly 10x earnings. So I don't think the comparison to AOL is fair.

  • Report this Comment On July 09, 2012, at 11:15 PM, Camacam wrote:

    The last time you looked at these ratios the percent was 80 and the net was -11 million. The trend is favorable. Granted it's a long way from 78% to 20%. Behooves us to continue monitoring.

  • Report this Comment On July 22, 2012, at 5:25 PM, crca99 wrote:

    Please do help us continue monitoring EBIX. I missed this consideration when I bought.

  • Report this Comment On July 22, 2012, at 5:37 PM, shamapant wrote:

    I think that you have to realize it's a balance. EBIX is a great company and it's growing through acquisitions(which have been working out favorably so far)....since organic growth is lacking, the market isn't valuing it on growth prospects-makes sense since acquisition based growth is very questionable. Still, it's a lot like Dell right now. If the acquisitions workout, intangibles won't mean a thing.

  • Report this Comment On October 26, 2012, at 11:07 AM, HappyAnvil wrote:

    As someone who works with one of Ebix's acquisitions, I can tell you that they are completely inept and unresponsive, and some of their other clients have the same problem. Not much "goodwill" from where I am standing.

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