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Technology Stocks : Cisco Systems, Inc. (CSCO) -- Ignore unavailable to you. Want to Upgrade?

To: Paul Reuben who wrote (45464)	12/29/2000 10:23:46 AM
From: bambs	Respond to of 77399

Let's say Company A exchanges $50 million in stock to acquire Company B in a pooling transaction. That $50 million is just as real as cash, perhaps even more real for investors that just experienced dilution in their ownership position. These investors are entitled to compensation for this transaction in the form of an adequate return on investment. How do they track this return? Without any record on the balance sheet, it's much more difficult for investors to determine. Here's a simplified example of what return on equity (ROE) would look like for two firms, one that used pooling, the other purchase. Remember ROE is equal to net income divided by average shareholders' equity. Pooling Purchase ROE $50/$160 $48.7/$200 ROE 31.2% 24.3% Why the difference? The firm that used purchase accounting gets a double whammy. First, it has a much larger equity base to earn a return on, since the sale of stock boosts paid-in capital roughly by the market value of the stock exchanged. Second, net income is reduced due to goodwill amortization charges. That's the problem with having two different accounting methods for mergers and acquisitions -- you end up with very different results for the same transaction. This is why it makes so much sense to eliminate pooling. The firm that uses purchase accounting is forced to earn a return on all that extra equity, and investors can see it happen. This is proper. The pricier the acquisition, the harder it is to earn a satisfactory return. The pooling firm gets off scot-free. and this is a good quote too.. Remember the income statement matches revenues and expenses during a given period. Is it fair that a company gets to record revenues, presumably some of which are the benefit of acquired goodwill, without allocating the cost of acquiring the goodwill concurrently? I'd argue that if you want to know how much cash a company is producing, ignore amortization charges; but if you want to look at its operating margins, add them back in, at least when looking at companies with large blocks of unamortized goodwill. When a company pays a large premium for an acquisition, that expense is part of the cost of doing business, and whether allocating it over fixed periods is accurate or not, I always prefer a conservative estimate to one I know is too high.