Justin Baer Report Via Bloomberg News

Professor's Z-score Gets High Marks: Flags Corporate Collapse
Justin Baer
Bloomberg News

08/28/2002
National Post

NEW YORK - When Needham & Co. analyst Mark Langley mentions the Altman Z-score in presentations to money managers, he often senses he has stirred distant memories of classrooms and finance textbooks among some clients.
The Z-score, introduced in 1968 by Edward Altman, is a mathematical formula that measures whether a company is at risk for bankruptcy. Some investors, analysts and bankers, who let the model gather dust during the 1990s while stocks surged, have rediscovered the Z-score's virtues as corporate bankruptcies head for a second straight record year.
"It's a tool that fell to the bottom of the toolbox during the bull market,'' said Mr. Langley, whose clients have told him they'd first heard of Altman's Z-score in business school.
The model, investors say, has endured because many companies with low Z-scores don't. Altman, a 61-year-old professor of finance at New York University, estimates that 85% to 90% of bankrupt companies had failing scores a year before their filing. A low score suggests bankruptcy may be more likely.
"It's still the standard,'' Mr. Altman said in an interview from his office at NYU. "First, and most important, it's still relatively accurate. Second, it's very quick and easy for an individual to do. Third, it's completely free.''
Adelphia Communications Corp., a cable-television company, and telecommunications-network operator Global Crossing Ltd., which both entered Chapter 11 bankruptcy this year, had low Z-scores a year before their filings.
This year, 134 companies have put a record US$268.1-billion in assets under court protection, according to Internet site BankruptcyData.com. In 2001, 255 companies filed for bankruptcy, listing assets of US$260-billion, almost triple the record that stood for a decade.
Altman, who created his original Z-score formula for manufacturers, has devised versions for service providers and private businesses. Students have taken it further, tailoring the model to individual industries. The final score is a sum of four or five variables.
For a manufacturer, a final score of 1.81 or lower suggests the company may fail.
For non-manufacturers such as Adelphia, a Z-score of 1.10 or less indicates bankruptcy is likely. The cable company had a score of 0.11 and Global Crossing had a 1.15 a year before their bankruptcy filings, according to Bloomberg data.
The models use ratios such as working capital, or the amount of money available to run a business, to total assets to measure whether companies are at risk for bankruptcy.
Currently, Nortel Networks Corp. has a -1.53 score.
"We do not comment on speculative reports and formulas,'' said company spokeswoman Tina Warren, who noted that the company's cash rose to US$4.9-billion on June 30.
Cisco Systems Inc. has a 5.17 score and 3M Co. has a 5.38 -- both considered high grades.
Cisco spokeswoman Abby Smith declined to comment. 3M spokeswoman Donna Fleming wouldn't comment.
Mr. Altman attributes the Z-score's emergence partly to chance. "I was looking for a dissertation topic,'' he said.
The professor, who receives more e-mails and calls than ever with questions on the Z-scores, said his models aren't perfect.
Sometimes, the same conclusions can be drawn from a cursory review of balance sheets and cash-flow statements, said Wendell Perkins, a money manager at Johnson Asset Management.
A score can swing from quarter to quarter when a company records one-time write-offs. Writedowns in the value of goodwill, or the difference between an asset's book value and purchase price, lower retained earnings -- a component of the formulas.
That can change the final score, suggesting that bankruptcy looms for a company that's not at risk, investors said.
JDS Uniphase Corp. has a -28.57 score, mostly because of goodwill writedowns that deepened losses.
"Such charges do not affect liquidity and are not directly indicators of possible bankruptcy,'' JDS chief financial officer Tony Muller said.
Then there are instances where a company's stated results aren't accurate. WorldCom Inc., the phone company that misreported US$7.18-billion in costs since 1999, had a 7.38 Z-score a year before its July bankruptcy, according to Bloomberg data.
Bill Vogel wishes he had used the Z-score to evaluate a former employer. The consultant worked at WinStar Communications Inc. from early 1999 until 2000. "It would have kept me from joining the company,'' he said.WinStar's Z-score at the end of 1998: -0.21. The carrier filed for bankruptcy last year.