There seems to be a lot of confusion about the charge to earnings. Let me see if I can clear it up a bit.
When WIND, or anyone else buys a company, they can either buy that company's stock, or they can buy the assets of the company, in which case the target would be left with only cash as assets. The shareholders would then have to liquidate the company to get the cash out.For both accounting (i.e. GAAP) purposes and tax purposes, it makes a difference whether you buy stock or assets.Further, you can pay for the acquisition with either cash or stock, which leads to further complications.
For a bunch of reasons, buyers almost always want to buy assets, and sellers almost always want to sell stock. This usually results in a buyer being willing to pay more for assets, and a seller willing to accept less for stock. To illustrate this, assume that you are the sole shareholder of Target, and Buyer offers you $10 million for your company. If he bought stock you would get $10 million, pay 20% capital gains tax, and be left with $8 million, before state taxes. (assume for this illustration that you started the company, and have no tax basis in the stock, and that the company has always written everything off, so it has no tax basis in its assets. In the real world there might be things like asset or stock basis, or tax loss carryovers. Now assume that Target sold its assets. Target would pay a 35% corporate federal income tax, leaving it with $6.5 million to distribute to you, the shareholder. When you got the $6.5 million, you would still have no basis in the stock, so you would owe 20% tax, or $1.3 million, leaving you with $5.2 million, again before state taxes, but this time at both the corporate and at the personal level. As a seller, which would you rather end up with, $8 million or $5.2 million?
Now pretend that you are the buyer, and are willing to pay $10 million for the company. If you buy stock, the assets of the company were not sold, so the company still has zero basis in its assets, and you get no depreciation. (Kind of like, when you buy WIND stock, the company doesn't get any extra depreciation.) The acquisition costs you $10 million, after tax. If, instead, you bought the assets of target, you would get to take $10 million of deductions, saving you 35%, or 3.5 million (time value of money ignored here). Your after tax cost is $6.5 million, before state tax savings. Which would you rather pay for the company, $10 million after tax or $6.5 million after tax?
From a financial statement viewpoint,an acquisition is always treated as an asset purchase (except in rare circumstances when it is treated as a pooling of interests, which is not germane to this analysis). What this means is that the buying company (WIND) records the fair market value of identifiable assets (land, buildings, accounts receivable, etc) on its balance sheet. The difference between the price paid and the FMV of identifiable assets is either recorded as the asset goodwill, or written off immediately, depending on the circumstances. If it is recorded as goodwill, it is written off over the estimated useful life, but not more than 40 years. For a high tech company, any life would generally be very short, on the order of 3 to 0 years. Fortunately, there is another alternative for high tech companies like WIND. They usually write off the cost of the acquisition immediately as in-process R&D. Using the above $10 million example, if you bought stock, you would have a $10 million after tax charge. If you bought assets, you would have a $6.5 million after tax charge.
If you were the CFO of WIND, which would you rather do--take a one time charge of $13 million (I forget the exact number) and identify it as related to the acquisition so that analysts will factor it into their conclusions, or reduce your operating earnings by $2.6 million (assuming $13 million is amortized over five years) each year for the next five years). Unless you are in the kind of business where you could write off the acquisition over 40 years, almost everyone would prefer the one time charge. Next year, you get the earnings with no charge.
So how does WIND end up with only a partial tax benefit? My guess is that it is a combination of the company they bought having some asset basis, plus a tax loss carryover. Since the same company is still in existence, the buyer ends up with these benefits.
The bottom line is that it really doesn't make much of a difference in how the company is valued. |
