Taking Stock of New Merger Rules
Recent sweeping changes to rules determining how U.S. companies account for mergers were expected to put the deep freeze on acquisitive-minded firms such as Cisco Systems Inc.
But since July 1, when the new rules went into effect, Cisco has announced its first two acquisitions of 2001.
In general, Wall Street deal makers are reporting few ill effects from the accounting changes ordered by the Financial Accounting Standards Board. In fact, some experts say the new rules provide greater flexibility in structuring deals and favor cash-rich buyers and hostile bidders.
By and large, corporate America has lined up behind the changes, which eliminate the use of “pooling” accounting in mergers. Pooling made it appear as if two merging companies had always been one by allowing the firms to record assets at their historical book values (cost minus accumulated depreciation).
When stock prices were soaring in 1999 and early 2000, pooling became the accounting method of choice for many companies, especially in technology. They were able to use their highly valued shares to acquire other firms without having their operating earnings hurt by “goodwill” write-offs--charges to account for the difference between the high price paid for assets and the generally much lower book value of the assets on the target company’s balance sheet.
Now, all companies must use the “purchase” method of accounting, which requires that assets be recognized at the price they were acquired, at least initially.
Many analysts have argued that such accounting gives investors a fairer picture of a merged firm.
However, to limit the potential for sudden massive goodwill charges against earnings, the new rules allow companies to avoid them unless the fair market value of acquired assets has become “impaired”--meaning the market value is less than the carrying value of the assets on a company’s books.
The new rules require all companies to initially test any goodwill sums on their books to determine impairment. Many companies, particularly technology firms that paid large premiums for other firms in recent years, are only just beginning to determine the impact of those reviews.
Intel Corp., for instance, recently said in a filing with the Securities and Exchange Commission that it has not fully assessed the impact of the new accounting rules.
But a goodwill review conducted by JDS Uniphase Corp. resulted in the firm posting a $50.6-billion net loss for fiscal 2001, which ended June 30.
JDS, the world’s top supplier of fiber-optic components, said last month that most of the loss was because of a nearly $45-billion reduction in the carrying value of goodwill on the company’s books--resulting from the crash in telecom asset values and telecom stocks over the last year.
“The impairment issue, in my opinion, is going to cause a lot of companies an awful lot of work to determine if they have to record goodwill [charges],” said Jim Harrington, a partner with PricewaterhouseCoopers. “I don’t know how many companies have really gone through an exhaustive analysis to this point.”
But experts said that isn’t the reason why merger activity has slowed this year.
Deal-making this summer is at its slowest pace since 1993, but analysts blame weak stock prices and falling corporate profits, not the accounting change. Indeed, many deal makers are reporting few problems putting deals together.
“Pooling [accounting] was essentially . . . very restrictive in terms of how you could actually structure certain things,” said Ammar Hanafi, a Cisco executive responsible for identifying and pursuing acquisitions, “whereas in a purchase-accounting transaction, everything is negotiable at some level.”
Doing away with pooling accounting also means that companies no longer have to abide by a two-year moratorium on selling acquired assets.
That, experts believe, will help create a more active environment for unsolicited or hostile merger proposals.
Indeed, several high-profile examples already have emerged, including Comcast Corp.’s unsolicited $40-billion bid for AT&T;’s broadband unit, Danaher Corp.’s offer to acquire Cooper Industries Inc. for as much as $5.5 billion and EchoStar Communications Corp.’s roughly $30-billion bid for GM Hughes Electronics Corp.
But the real impact of the accounting changes can’t be measured until the overall merger market picks up again, some experts said.
“I don’t think that we’ve seen enough transactions to know yet,” said Rich Escherich, a managing director with J.P. Morgan Chase’s merger and acquisition group.
