For nearly two years, Irvine chip maker Broadcom Corp. dazzled Wall Street analysts with its explosive growth and voracious appetite for strategic acquisitions.
But now, some of the company's admirers are questioning whether Broadcom's financial reporting practices on five acquisitions might have understated the real cost to the company.
In what analysts say is an unusual arrangement, Broadcom encouraged five companies it was acquiring to issue warrants--rights to stock--in their companies. The warrants were issued to customers as encouragement to continue purchasing products. Broadcom then would pick up those warrant obligations in the acquisitions.
What it did next, though, has led to growing concern on Wall Street. Critics charge that the warrants are essentially discounts on products and that their expense should have been used to reduce revenue and income.
Broadcom instead classified the warrant expense as goodwill--an often-overlooked category that represents the amount paid over the value of the company acquired.
Still, critics say, Broadcom has been buying customers. News of its accounting methods Tuesday sent the already battered stock down to a 52-week low of $53.13 a share during regular trading. It closed at $53.63, down $9.38 a share.
"Any time a company offers some sort of bribe to get its products out in the market, then that in essence reduces the net revenues obtained from the sale of those products," said E. John Larsen, a professor at USC's Leventhal School of Accounting.
"This is cute accounting, and I would not stand for it if I were the auditor," he said.
Broadcom defended the accounting method it used on five of its 12 acquisitions last year.
"I think people don't understand it," said William Ruehle, Broadcom's chief financial officer. "I think some competitors don't think this is cool because it gives us a competitive advantage."
Ruehle said he did not know whether Broadcom would use the same tactic in future acquisitions, and he downplayed its relevance to the company's overall financial health.
Criticism of the practice has been swelling among Wall Street analysts and accountants for several months as the industry has been going through a massive slowdown.
"This was designed to obtain an accounting result, not a financial result," said one senior executive at a top five accounting firm. "They don't want to show their product being discounted substantially."
Others, however, say Broadcom's tactics are an outgrowth of the highly competitive market.
"This tactic is one that some competitors probably envy because Broadcom had the advantage," said analyst Charles Glavin of Credit Suisse First Boston. "Do you condemn them or condone them? I don't think that's the point. The lesson is that in this environment, people are being very aggressive, and it reflects a weakening industry environment."
David Wong, an analyst at UBS Warburg, sees nothing wrong with Broadcom's accounting strategy.
"I think it's a good practice provided there's no confusion and no subterfuge," he said. "These aren't any facts that I couldn't have gotten by reading what's publicly available" from the company.
The accounting method was used in Broadcom's acquisitions of Altima Communications Inc., Silicon Spice, Allayer Communications, Sibyte Inc. and VisionTech. The warrants, if all of them are exchanged for stock, could total about 11 million shares of Broadcom stock, less than 5% of the more than 250 million Broadcom shares currently outstanding, Ruehle said.
As Broadcom began negotiating to buy the companies, it encouraged them to issue warrants to their customers promising to sell stock for literally pennies a share, in exchange for the customers' agreements to continue buying their products over time.
"It's one more way of solidifying the company's relationships with their customers," Ruehle said. "We are asking them to give us more evidence that they're going to meet their targets."
When the acquisitions are completed, the warrants become Broadcom warrants. Over time, they can be exchanged for Broadcom stock if the customers buy the products they agreed to purchase.
Broadcom could have accounted for the expense of the warrants as a reduction in revenue and, in turn, income. But it chose to list it as goodwill, which is an asset on Broadcom's balance sheet, not a liability.
The stock has fallen about 80% from its high of $274.75 a share in August.