a characterize the effect of the xmi expensing policies with respect to acquisitions 543630 | Homework Solutions

You are researching XMI Corporation (XMI). XMI has shown steady earnings per share growth (18 percent a year during the last seven years) and trades at a very high multiple to earnings (its PIE ratio is currently 40 percent above the average PIE ratio for a group of the most comparable stocks). XMI has generally grown through acquisition, by using XMI stock to purchase other companies. These companies usually trade at lower PIE ratios than XMI.

In investigating the financial disclosures of these acquired companies and in talking to industry contacts, you conclude that XMI has been forcing the companies it acquires to accelerate the payment of expenses before the acquisition deals are closed. Such acceleration drives down the acquired companies” last reported cash flow and earnings per share numbers. As one example, XMI asks acquired companies to immediately pay all pending accounts payable, whether or not they are due. Subsequent to the acquisition, XMI reinstitutes normal expense payment patterns. After it acquires a

company, XMI appears to have a pattern of speeding up revenue recognition as well. For example, one overseas telecommunications subsidiary changed its accounting to recognize up front the expected revenue from sales of network capacity that spanned decades. The above policies and accounting facts do not appear to be have been adequately disclosed in XMI”s shareholder communications.

A. Characterize the effect of the XMI expensing policies with respect to acquisitions on XMI”s post-acquisition earnings per share growth rate.

B. Characterize the quality of XMI earnings based on its expensing and revenuerecognition policies with respect to acquisitions.

C. In discussing the current price of XMI, the question states that XMI”s “PIE ratio is currently 40 percent above the average PIE ratio for a group of the most comparable stocks.” Characterize the type of valuation model implicit in such a statement.

D. State two risk factors in investing in XMI, in the sense in which that term was used in the discussion of quality of earnings.