Everybody Out of the Pool? A New Math on Mergers
nytimes.com
January 7, 2001
Everybody Out of the Pool? A New Math on Mergers
By ANDREW ROSS SORKIN
he funny thing about most big mergers and acquisitions is that they don't cost anything. Yes, they are free. PepsiCo may have agreed to pay $13.4 billion for Quaker Oats as the newspaper headlines will attest, but Pepsi's balance sheet will not show the $13.4 billion cost.
The Financial Accounting Standards Board, an obscure but powerful authority that makes the rules for corporate accounting, is about to change that. Its new standard, which many companies and investment bankers have long feared would be a deterrent to takeovers, could fundamentally alter the landscape for who buys whom. More important, deals might actually begin to cost something.
The board's members are expected to ratify the new rule next month. Although it would not take effect until the end of June and could contain a potentially significant loophole, the change has the world of takeover lawyers and investment bankers abuzz. Wheeling-and-dealing companies and their advisers are taking sides, disagreeing about how the change would affect them and their ability to gobble up their rivals.
At issue is how a company should account for the premium it has paid to buy another company — the part of the purchase price that exceeds the fair market value of the acquired company's assets. (That difference is known as good will.)
Currently, for most major transactions that are paid in stock, companies use a kind of accounting method called pooling. It allows the buyer to disregard the premium paid — as long as it does the deal solely in stock, refrains from selling the acquired company's core assets for at least two years and refrains from buying back any of its own stock for six months.
Accountants and shareholder advocates have long complained that pooling is basically unfair. They contend that it gives companies that have highly valued stock an unfair advantage in takeover contests. And, they say that pooling allows companies to hide the actual cost of an acquisition, and that this cheats investors of an important opportunity to gauge the value of a deal and decide whether it makes sense.
"Pooling underreports the cost of business combinations, it produces grossly distorted balance sheets and it provides managers with the means to lie about future corporate earnings," said J. Edward Ketz, associate professor of accounting at Pennsylvania State University's Smeal College of Business Administration.
Under the accounting board's proposal, all buyers would account for takeover deals the old-fashioned way, a method known as purchase accounting — showing on their balance sheets the amount of the transaction. The buyers would do this essentially by gradually subtracting the premium paid from their own earnings, known in accounting parlance as amortization of good will. To most reasonable people, this probably sounds like a simple and logical reform to promote openness and honesty — "transparency" is the term accountants like to use. But to many company executives and deal makers, purchase accounting in takeovers is overly simplistic. They think it will do far more harm than good.
They argue that the change would effectively cripple their ability to do blockbuster deals because, in many cases, the premiums would be so huge that it would be impossible to subtract them from the buyer's earnings without putting the buyer out of business.
"The earnings charge resulting from the amortization of goodwill has made purchase accounting unattractive in many cases," H. Rodgin Cohen, chairman of the New York law firm Sullivan & Cromwell, wrote in a recent note to clients. That is particularly true, he added, when the purchase price is many times a company's net asset value — as has been the case in many recent media and technology mergers.
The accounting board's proposal has prompted such a storm of protest that it has recently devised what may be a practical compromise. It would still prohibit use of the pooling accounting method in takeovers. But it would adopt one pool accounting practice: buyers would not have to account for premiums paid unless those premiums become "impaired," meaning that they lose value — say, because an industry changed drastically.
This compromise may turn out to be a gaping loophole, analysts warned. Because buyers would have some discretion in deciding when an acquisition is "impaired," theoretically, they might never need to account for the cost of takeovers — basically the same situation that exists now.
"Such guessing games do not belong in financial reports," Professor Ketz said. "The impairment test invites abuse by corporate managers."
Some deal makers believe that the proposed compromise would help their business by giving all potential buyers the same accounting rule, creating a more level playing field. Jack Levy, a co-chairman of mergers and acquisitions at Goldman, Sachs, said: "It creates a greater measure of fairness for U.S. and non-U.S acquirers, the latter of which didn't have the same pooling restrictions. And it certainly will allow a company that didn't have a multiple to consider making proposals."
To better understand how accounting affects takeover deals, consider the often- cited example of America Online's acquisition of Netscape Communications in 1998. That deal was done under the pooling method, so AOL did not have to reflect the premium it paid for Netscape in its earnings. That was true even though, while AOL paid $10.2 billion in stock for Netscape, Netscape's net assets were worth only $700 million, giving the deal a huge $9.5 billion premium. If AOL had used purchase accounting for the transaction, it would have been required to deduct $9.5 billion from its bottom line, a move that could have bankrupted the online service. Instead, AOL went on to report record earnings and growth.
Had AOL acquired Netscape under the accounting board's proposed change, the results would have been vastly different — even under the compromise. By almost all measures, Netscape's value has become severely impaired since AOL bought it. How impaired would be a subjective call.
The accounting change could spur more hostile takeovers. "More topping bids could emerge following the announcement of friendly mergers because, among other reasons, `pooling busting' defensive arrangements would no longer be a deterrent," Mr. Cohen said.
Some analysts say the accounting change should also benefit leveraged buyout firms, which have used cash — borrowed or not — to buy companies since they have no stock to use as currency. As a result, the buyout firms were forced to use the purchase accounting method and thus skipped any deal with a high premium that would have forced them to take a hefty charge against earnings. Under the change, such firms would be on the same footing with corporations when it comes to using cash or stock as currency, at least theoretically.
Of course, a cash-rich corporation would still be able to outbid most leveraged buyout firms. And the market for debt is so poor right now that cash most probably would not be the currency of choice, at least until the debt market returns.
Copyright 2001 The New York Times Company |
