Bursting The Merger Balloon

Dec. 21, 2004
High-tech industry says it would be particularly hard hit by new accounting rule.

Could a merger accounting rule expected to go into effect next year put an end to the merger mania sweeping corporate America? Opponents of the new rule, currently under consideration by the Financial Accounting Standards Board (FASB), contend that it will make corporations far more reluctant to make major acquisitions and incur the cascades of red ink -- at least on paper -- the deals will cost them. The rule will affect all U.S. companies. "The effect on earnings will be enormous," says Carl A. Thomsen, senior vice president and CFO at Digital Microwave Corp., San Jose. "[Companies] won't do these megamergers anymore." At public hearings in San Francisco and New York last month, FASB's proposal to eliminate the "pooling of interests" method of accounting for corporate mergers drew heated opposition from high-tech-industry CFOs. The new measure would require companies to account for mergers using the "purchase" accounting method, which would force acquiring firms to take huge charges against earnings in many cases. In effect, the new requirement would mean that acquiring firms doing the multibillion-dollar mergers taking place almost daily would be forced to show the actual costs of these deals on their bottom lines. A final standard is expected to be issued by the end of 2000. The high-tech industry would be particularly hard hit. "Acquisitions are a key ingredient to success for companies in the high-tech area," Thomsen told FASB members during a San Francisco hearing. They've also become a way of life. On Feb. 7 four mergers totaling $11 billion were announced in the high-tech industry: Corel Corp. will acquire Inprise/Borland Corp.; Lucent Technologies Inc. said it will purchase Ortel Corp.; Kana Communications Inc. plans to gobble up Silknet Software Inc.; and Akamai Technologies Inc. will absorb InterVU. Under the current setup, most deals are accounted for using the "pooling" method. This basically allows acquiring firms to ignore the fact that they paid a much higher price -- usually in stock -- for the companies they purchased than the companies' actual asset values. The difference reflects a host of intangibles, including such things as intellectual property but also "goodwill" -- the value of a company's name. Although high tech would be acutely affected, almost every manufacturer acquiring another firm for a price premium over the acquired company's net asset value would see a negative impact on the bottom line due to the accounting change. For instance, in the pharmaceutical industry, Pfizer Inc. is merging with Warner-Lambert Co. in a $92 billion stock deal. The acquired firm, Warner-Lambert, has assets of about $9 billion, according to its latest annual report. In other words, Pfizer is paying $83 billion for intangibles, including drug patents and goodwill. If that deal were done under the proposed new rule, Pfizer would be required to amortize all the intangible assets, including goodwill, against reported earnings over a period of 20 years or less. That would mean Pfizer would have to take a negative change against earnings of about $4 billion. Some CFOs at the hearingsexpressed concern that acquiring companies will be penalized for doing so at a time when the acquired firm's stock was at an extremely high price, thereby inflating the amount of goodwill that they will have to amortize. "The value of goodwill is arbitrarily determined based on the stock price at some date," observed Thomsen, who noted that Digital Microwave's share price had fluctuated from $27 to $37 in a recent week. "It's hard for me to believe the goodwill of our company has changed by that much in one week," he said. FASB's position is that these deals proceed with no real accounting to shareholders of exactly how much was paid and for what. "We think investors need the same kind of information with respect to every business transaction," explained Edmund L. Jenkins, chairman of FASB, Norwalk, Conn. "The financial statements should reflect the value associated with each transaction, so that investors can hold management accountable for investments in other businesses. The pooling method of accounting doesn't provide that information." Added FASB member Gaylen Larson, "You need to have all the information in front of you, and you need to know the cost of an acquisition . . . ." Several CFOs attending the hearings say they believe investors may simply disregard the bottom-line figures showing acquisition-related losses as a result of the new ruling. "I am troubled by how, if these rules are implemented, the investment community will disregard the numbers and use separately calculated financial results," says Mercedes Johnson, CFO at semiconductor manufacturing equipment maker Lam Research Corp.

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