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Hedge fund manager Eric Sprott on Friday, November 25, 2010.Darren Calabrese/The Globe and Mail

Sprott Inc. investors are likely looking at a significant writedown from the company now that it has admitted that its recent acquisition of another hedge fund company has been a bust.

Sprott paid $10.7-million just a few months ago for Flatiron Capital Management Partners. Monday's revelation by Sprott that Flatiron's managers have been replaced, assets at Flatiron have shrunk by almost half and one of the funds is being closed suggests that the company may have to write off much of that purchase price. (Streetwise's Tim Kiladze outlines what went wrong in this previous post.)

After the acquisition, Sprott ascribed $3-million of value to fund management contracts at Flatiron, and $8.7-million was classified as goodwill. Sharp-eyed readers will note that is more than the purchase price, but there were some liabilities purchased as well that help explain the difference.

It's hard to see how much if any of that goodwill can survive an impairment test. Most of the value that Flatiron was supposed to bring is gone. The present business is seriously compromised, as is any future growth that goodwill was supposed to represent. The fund management expertise is gone. The name Flatiron is not worth much at this point.

If Sprott is forced to write down the goodwill to zero, that would take a good chunk out of net income. Sprott earned $11-million last quarter.

From a pure valuation standpoint, it will be characterized as a non-recurring item and investors may not pay that much notice. What may be more of an issue is the effect of the problems at Flatiron and on Sprott's ability to sell funds.

Judging by the hammering Sprott shares are taking Tuesday, investors have decided that the Flatiron situation is a problem.

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