Cherchez la footnote
Elizabeth MacDonald, Forbes Global, 01.07.02
Companies that list ADRs may offer a second peek at profits, but accounting that's inconsistent with U.S. standards is still likely to leave investors puzzled.
If you want to run a telecommunications company, Britain is the place to keep your books. Look at Colt Telecom in London, whose American Depositary Receipts (ADRs) trade on Nasdaq. Using British accounting methods, Colt reported a $29 million loss for the fourth quarter of 2000. Under U.S. accounting rules it would have reported a $51 million loss.
A well-executed strategy of international diversification can reduce portfolio volatility. But no matter where you invest, it's worth checking the profit numbers closely. Companies with ADRs offer investors a "second opinion," the chance to compare accounts using the U.S.' generally accepted accounting principles (GAAP) with what's in their local books.
In Britain, for example, telecoms immediately book revenue from sales of transmission space on their networks; U.S. rules force companies based there to spread that revenue over the life of these contracts, says Jay A. Huck, an accounting expert at the Center for Financial Research & Analysis, a research boutique in Rockville, Maryland.
Such accounting differences are all too typical for ADRs, (see table, below). But explanations are harder to come by. A non-U.S. company whose ADRs trade on any U.S. exchange (including Nasdaq) is supposed to disclose a reconciliation of its profit and shareholder equity under GAAP in filings with the U.S. Securities & Exchange Commission (SEC). Unfortunately, many disclose only these two numbers instead of filing full statements to show how they arrived at those results, so investors can't do a proper earnings analysis, says Trevor S. Harris, an international accounting expert at Morgan Stanley. Also note that companies whose ADRs trade over the counter through programs at big banks don't have to disclose any results under U.S. rules.
Mind the GAAP
Non-U.S. outfits show sweeter profits at home than their adrs do under the U.S.' more restrictive Generally Accepted Accounting Principles.
Company / Country local GAAP US GAAP
Akzo Nobel / Netherlands $3.11 $2.40
Alcatel / France 1.15 -0.42
BOC / UK 1.05 0.86
GlaxoSmithKline / UK 2.08 -4.41
Imperial Chemical Industries / UK -0.48 -0.96
Royal Ahold / Netherlands 1.39 1.00
Taiwan Semiconductor / Taiwan 0.90 0.30
TotalFinaElf / France 4.50 3.72
United Microelectronics / Taiwan 0.15 0.08
Better than a second opinion might be more consistent standards across borders. Don't count on the SEC to monitor this situation closely, though. The agency is preoccupied with domestic problems, such as sorting out the Enron mess. Though the agency says that it's on guard, the SEC's website (www.sec.gov) shows just two accounting enforcement actions since 1998 against non-U.S. companies that trade as ADRs; there were 388 filed against U.S.-based companies.
ADRs, which have been around since 1934, represent claims on foreign shares, but they trade in dollars, and their dividends are paid in dollars. The count of issuer-sponsored listed ADRs has climbed in the past five years from 322 to 539. And you don't have to be American for them to be a sensible way to invest. A German investor, say, might find it easier to deal with a Chilean ADR listed on the New York Stock Exchange rather than fool around on the Santiago exchange.
Financial websites, including the SEC's own site, offer precious little in the way of non-U.S. filings. There is some hope for relief from muddy accounting: Big companies are beginning to adhere to a new uniform set of international accounting standards that comes pretty close to GAAP. If the U.S. approves these standards--and it's a big if--those companies that comply will be able to list their shares on U.S. exchanges. But plenty of non-U.S. outfits could disregard those tough rules and still have ADRs trading.
"Foreign companies are getting at our capital without having to conform to our higher [disclosure] standards," laments Fredric E. Russell, who heads an investment management firm in Tulsa, Oklahoma. "It's like a university waiving its academic standards for athletes."
Here's one thing to watch out for, says Howard Schilit, who runs the Center for Financial Research: a smoothing-out of earnings by manipulating reserve accounts. Alcatel, the French telecom supplier, has a history of drawing down reserves to paper over a bad quarter.
Philips Electronics, the Dutch giant, which trades on the New York Stock Exchange, reported that its income in fiscal 2000 from continuing operations (that is, excluding one-time gains) had jumped a spectacular 65%, to $2.2 billion. Investors needed to dig to learn that two thirds of the increase came from transfers Philips made from its receivables reserves ($105 million) and because it got $438 million from its employee pension fund. A company spokesman defends the accounting and says that a new company policy caused the reserves to dip.
U.S. companies are occasionally caught backdating contracts to improve poor quarterly numbers. Non-U.S. companies are just as brazen. Akzo Nobel, a Dutch pharmaceuticals maker, announced that it would take a $240 million restructuring charge against second-quarter earnings. But it neatly offset the charge with gains from the $271 million sale of its in vitro diagnostics unit. Although its filings state that the sale became effective June 30, the last day of the quarter, a press release dated July 3 indicated that the acquirer, BioMrieux, hadn't yet paid the $271 million--and that the sale "will only come into force as soon as merger control clearance has been obtained" in certain countries. (A spokesman says that most of the sale has now been completed.)
Here's another neat trick: booking revenue from barter deals in which little or no money changes hands. ActivCard, a French player in digital identity and electronic certification technology, is a hot stock because of the war on terrorism; the U.S. Defense Department is a client. The company got 36% of its third-quarter revenue from a license swap with VeriSign. Specifically, ActivCard says that it sold a $3.2 million license to VeriSign and bought a $3.4 million license from the same company. ActivCard counted the $3.2 million as revenue in full, even though it got the money in late October, but it will spread its $3.4 million outlay over three years. ActivCard's Nasdaq-listed ADRs are up 63% since Sept. 21, to $9. Blair Geddes, ActivCard's CFO, insists that under U.S. GAAP the company had no choice but to report the transaction the way it did.
Despite deepening losses--$108 million in 2000 versus $35 million in 1999--Equant, a telecommunications services provider in Amsterdam, has an ADR price on the New York Stock Exchange of $12.64, which gives it a market cap of $2.5 billion. What's propping up this moneyloser? Revenue growth: $1.5 billion in 2000 from $1 billion in 1999.
But watch out. Much of that jump can be attributed to back-scratching deals with affiliated companies, which increased 90% in 2000, to $482 million, a third of total revenues. The customers: SITA-Equant, a joint venture with SITA, a telecom outfit in Geneva; and Radianz, a joint venture between Equant and Reuters. Does the SITA joint venture operate at arm's length from Equant? Scarcely. SITA has a contract to sell Equant its 50% interest in the venture. The only reassurance for investors who wonder about Equant's future revenue is that SITA has agreed to buy a minimum of $500 million in services from Equant in the 12 months after the deal is completed.
Equant didn't return calls for comment.