From tomorrow's WSJ:
March 31, 1999
Heard on the Street
Netscape Deal Could Mean
Years of Charges for AOL
By THOMAS E. WEBER and ELIZABETH MACDONALD
Staff Reporters of THE WALL STREET JOURNAL
Who really bought Netscape Communications?
The simple answer is America Online, which closed its acquisition of
Netscape two weeks ago. Yet while AOL paid the bill -- some $10 billion
of AOL stock -- it has been clear that Sun Microsystems will hold some
sway over a large chunk of Netscape, thanks to a new Sun-AOL alliance.
Just how much is only now becoming
apparent. Last week, AOL and Sun unveiled
their alliance, which tellingly will be headed by
a Sun executive. Tuesday, at a joint company
briefing, executives spoke at a lectern backed by a large Sun logo, flanked
by smaller AOL and Netscape logos. The companies also referred to their
venture as the "Sun-Netscape" alliance, rather than the "Sun-AOL
alliance," as they had described it last week.
But make no mistake: The depth of Sun's involvement is more than
symbolic for AOL shareholders. That's because it could affect the way
AOL is allowed to account for the transaction. If regulators conclude that
Sun effectively purchased Netscape's corporate-software business, AOL
could be forced to account for the deal differently. AOL could then incur
as much as $9.7 billion -- yes, that's billion -- in "goodwill" charges against
earnings over a number of years. Goodwill represents the amount AOL
paid for Netscape above the net fair value of the company's assets.
Business: Online service provider
Six months ended Dec. 31*
1998
1997
Revenue (millions)
$1,819
$1,114
Earnings (millions)
$228
$64
Diluted per-share earnings
$0.41
$0.13
Latest quarter (Dec. 31, 1998):*
Diluted per-share earnings: $0.22 vs. $0.06
Average daily volume: 27,467,458 shares
Shares outstanding: 1.03 billion
Trailing P/E: 498
Dividend yield: none
*Figures not on fully taxed basis because company's tax provision continues to be
substantially offset by utilization of net operating loss carryforward
The upshot: AOL would incur between $96 million and $243 million in
annual earnings charges, using a conservative 40-year write-off period.
AOL had net income of $91.8 million for its most recent fiscal year ended
June 30.
"I'm a little uneasy," says Abhishek Gami, Internet analyst at William Blair
& Co. and one of those raising concerns about the issue. A restatement,
he adds, "would just kill AOL's earnings."
Not a problem, AOL says. Officials at the online-service giant say they are
confident the company has met the accounting requirements. "We feel very
comfortable that we have the structure and management team in place to
make the strategic alliance a real success and at the same time meet the
letter and spirit of the accounting rules," says Mike Kelly, AOL's chief
financial officer.
At issue is an accounting method called "pooling of interests," which
enables companies to avoid massive goodwill charges to future earnings.
These days, however, pooling is under fire from securities regulators and
accounting specialists. It also carries strict requirements -- including one
that bars a company from selling a significant portion of the acquired firm's
assets within two years of the deal.
Industry executives speculate that Sun will eventually buy these Netscape
assets two years after the deal closes, in keeping with the pooling rules.
But accounting experts say AOL could risk such a sale within those two
years, by arguing it didn't have a plan to dispose of these assets when it
entered into the pooling.
Netscapade? An Issue of Control
America Online
America Online bought Netscape, but some think Sun will call the
shots.
Paid stock valued at $10.2 billion to acquire Netscape.
Placed James Barksdale, Netscape's chief executive, as a director
and put top Netscape executives in key AOL positions.
Sun Microsystems
Pledged to buy $500 million of Sun hardware and services.
Agreed to pay AOL at least $975 million over three years,
representing guaranteed revenue for Netscape products that Sun
sells through the alliance.
Also agreed to pay AOL a $275 million one-time licensing fee.
Placed Mark Tolliver, a Sun executive, in charge of the Sun-AOL
alliance.
Sun makes a variety of computer hardware and software products,
primarily for corporate use. AOL, in contrast, is primarily a consumer
company that provides a gateway to the Internet. Netscape produces a
Web site that appeals to consumers, as well as software sold to
corporations. It is Netscape's corporate products, such as software for
processing electronic-commerce transactions, that Sun will market through
its AOL alliance.
When AOL signed its Netscape deal in November, the stock swap initially
valued Netscape at about $4.3 billion. The value soared to $10.2 billion at
the closing as AOL's stock price jumped. Estimates aren't available for
Netscape's net fair value, but Netscape's book value was about $475
million at Oct. 31. Thus, the goodwill involved could range from a total of
$3.8 billion to $9.7 billion.
Privately, AOL officials were concerned throughout the transaction talks
that the U.S. Securities and Exchange Commission might reject the pooling
treatment, people close to the company say. Adding to the anxiety: In
recent months, the SEC has gone so far as to force companies to account
for all stock acquisitions as if they had been cash purchases instead, thus
incurring goodwill charges. Those moves have been part of a general
crackdown on pooling.
An SEC spokesman declined to comment on the AOL matter.
In June, the Financial Accounting Standards Board plans to issue a
proposal to kill pooling, which corporate executives expect will take effect
Jan. 1, 2001. If the rules are adopted, companies will have to account for
their deals as purchases, and thus incur goodwill profit charges. But some
accounting analysts, speaking generally, say that certain companies may be
stretching the pooling rules to the point of breaking in their zeal to beat the
FASB deadline.
Sun says it is treating Netscape as a third party, not as a captive. "It is
absolutely not the case that Sun is taking control over the Netscape
enterprise-software business," a Sun spokeswoman says. "It is a critical
and important partnership that is very evenhanded." Sun's new joint
venture with AOL plans to use "as much or more" software from the
former Netscape as from Sun in its new generation of
electronic-commerce software, she adds.
Yet it is clear that Sun's involvement was crucial to the AOL-Netscape
agreement. AOL was anxious to get its hands on Netscape's Netcenter
portal. AOL was similarly enticed by Netscape's Communicator browser,
which millions of consumer and business users rely on to surf the Web.
AOL knew it needed help with Netscape's enterprise software, the
corporate packages that help companies run their Web sites. Sun, as a
giant corporate supplier -- and an avowed enemy of Microsoft -- was a
logical partner.
In concert with its deal to acquire Netscape, AOL entered an alliance with
Sun. When the details of the AOL-Sun agreement were disclosed in SEC
filings in February, they showed a huge financial commitment by Sun.
As part of Sun's agreement to sell Netscape's business software, Sun
guaranteed AOL would receive at least $975 million in revenue over three
years. Sun also pays AOL a one-time $275 million licensing fee and $10
million a year in cooperative marketing. AOL, meanwhile, agreed to buy
$500 million of Sun hardware and services, as well as pay Sun $1 million a
month for technical support and $5 million a quarter to license Sun
technology.
AOL is no stranger to accounting controversy. For years, it amortized its
marketing expenditures out as much as two years into the future -- a
practice that drew criticism from some who said AOL was trying to inflate
present earnings. AOL scrapped the approach in October 1996 and took
a charge of $385 million to write off its deferred costs.
Analysts say it's difficult to handicap how the Netscape transaction will
play out. "From what I heard about it [the AOL-Netscape deal], they've
walked a very thin line here," says Janet Pegg, an accounting expert at
Bear Stearns. In particular, Sun can't be seen to have direct management
control over the Netscape assets in the alliance, a critical part of the
pooling rules.
But Ms. Pegg adds: "Stock analysts have not seen it [the deal] as a slam
dunk that Sun would end up with the assets in the alliance."
--David P. Hamilton contributed to this article. |
