If you think new accounting rules will make acquisitions
more transparent,
think again. By Andrew
Osterland
A T FACEVALUE, FAS141 AND 142, the new
purchase-accounting rules issued by the
Financial Accounting Standards Board,
would seem to be another blow to a mergersand-acquisitions market already down in the
dumps. The new disclosures required of companies about their mergers will, in theory,
provideinvestorswith more-meaningful
information aboutthe performanceof
acquiredbusinesses
and,by extension,
of
the managerswho executethe deals.
Underthe former pooling-of-interestsaccountingmethod,the purchase
priceof a companywasunaccountedfor
afterthe dealwasdone.And underthe
old purchase-accounting
method,goodwill
amortization
charges
could be
passedoff asmeaningless
bookkeeping
How
exactly
does
FAS
142
to holdmanagers
moredirectlyaccountablefor the
prices they pay for other
companies.
Why thenwould Pfizer
Inc. offer a hefty 44 percentpremiumovermarket
pricefor Pharmacia
Corp.?
W"It h P'Izer
"'
s purc
hase
give large, diversified companies an
advantage over smaller ones when making acquisitions?
Example: companies A and B are interested in buying company C. Company A
has two business units with book values of $500
lion each with no recognized goodwill.
million
one business unit with a book value of $500 million,
a fair value of $800
and no goodwill.
If company C has a book value of $300
of $500
$200
million,
and fair values of $1 bil-
Company B, on the other hand, has only
million,
million and a fair value
to each of its business units, causing their book values to rise to $750 million,
million balance of goodwill.
ever, are now $1.25 billion,
with
The fair values of the units, how-
and the value of the acquired business could complete-
ly evaporate without an impairment
charge being required.
Company B's book value would rise to $1 billion and its fair value to $1.3 billion. The combined entity would have to take impairment charges if the value of the
business falls by more than $300
million.
Because of the lower implied balance of
created goodwill at company B, it would be less likely to offer a large pre-
mium than company A. + A.D.
PHOTOGRAPH
BY TRACEYKROLL
armacla. "~~
we
have
In the largest deal of the year, the
pharmaceuticalsgiant forked out $60
billion in stock for Pharmacia,which
on June 30 had a book value of just
$12.2billion. Pfizer has yet to issue
financial statements reflecting the
Pharmaciapurchase."Wehave an opportunity to be the posterchild for the
new purchase-accounting method,"
saysDavid Shedlarz,Pfizer'schief financialofficer.
INTANGIBLE
SAFETY
NETS
In company A's case, it would allocate half the assets of the acquired business
internally
, Ph
million of goodwill would have to be added to the acquir-
er's book value.
each having a $100
0
Like all CFOs involved with mergers,
Shedlarz has had his hands full in the
wake ofFAS 142. The new rules require
him to allocate the $60 billion purchase
price to Pfizer's existing business units.
He also has to mark up Pharmacia'sassetsto fair value and identify intangible
assetsto be amortized going forward. "I
like the pooling-of-interests method better," saysShedlarz.
At the end of the day,however,the new
OCTOBER 2002
I CPO
31
also prevent companiesfrom subsuming
acquired goodwill within undervalued
business units, and from ever having to
take impairment charges."It would have
a big impact on pricing for acquisitions,"
saysKing.
In the caseof pfizer, Pharmacia's assetsand goodwill would be distinguishable from pfizer's own business,and if it
were to deteriorate, it would be visible to
the market. As the rules now stand, deterioration would likely go unnoticed.
"Pfizer'sbook value is way below its market value, so it's easyto slip in a lot of
goodwill without risking future impaircia's drug pipeline dries up or generic fore impairment would becomean issue ment," saysKing.
If FASB's intent is to make the percompetition erodesits margins,the com- (see "How 1 + 1 = 3," page 31).
The solution, saysAlfred King, vice formance of acquisitions more transparbined entity still might not face impairment chargesin the future. How so?FAS chairman of Valuation Research,is to put ent to the market, it has work to do be142 and the rules for allocating goodwill a value on internally generated intangi- yond FAS142. *
to the business units of the acquiring ble assets,something currently on the
company are such that impairment FASBagenda.That, of course,would cre- ANDREW OSTERLAND (ANDREWOSTERcharges,particularly for large companies atehuge amountsof newbusinessfor ap- LAND@CFO.COM) IS A SENIOR EDITOR AT
CFO.
like Pfizer,are unlikely to occur. That be- praisal experts like King. But it would
ing the case,FAS142 isn't likely to foster
any more pricing discipline on the part of
buyers.
The new accounting rules require
companies to assign all acquired assets,
The
best
time
to break
bad
news
is when everybody else is,
including goodwill, to identifiable busitoo. Following that rule of thumb, most companies with large amounts of goodwill
ness units. If the purchaser is a large
on their balance sheets have written off huge portions of it in the initial impaircompany with a fair value that is much
ment reviews mandated by FAS 142. With all the noise that accompanies a colgreater than its book value,the acquired
lapsing stock market, mega-write-offs due to accounting changes haven't garnered
assetscan disappear into the combined
a lot of attention. "The effects of an accounting policy change are likely to be disentity. Any deterioration of the acquired
counted or ignored by the market," says accounting analyst Bob Willens of
assetswould be masked by the compaLehman Brothers. "We tell clients, if they're going to have an impairment, take it
ny's other businesses,particularly if the
goodwill can be divided into small pieces
big and take it this year."
AOL Time Warner, for example, took a charge of $54 billion in the first quarter,
and allocated to multiple reporting
erasing more than 40 percent of the combined company's balance of goodwill. last
units.
year, JDS Uniphase, the once high-flying manufacturer of optical networking gear,
"Large, diversified companies that
wrote off more than $50 billion of goodwill arising from various acquisitions, includdon't have fully loaded balance sheets
ing SDL and E-Tek Dynamics. "The prevailing view is that if a company is at all at
[that is, little goodwill] have less risk of
risk of a write-down in the next two or three years, it should take it now," says Alfred
future impairment," remarks one pubKing, vice chairman of Valuation Research.
lic accountant who asked for anonymiThe upside of the strategy is that going forward, there is less goodwill remaining
ty. In Pfizer's case, its largely unacto suffer possible impairments. The potential downside is that companies that use
counted-for intangible value will shelter
conservative valuation methodologies in their initial impairment reviews have to
it from the risk of future impairment to
stick with those same methodologies in their future reviews. The valuation alternagoodwill arising from the Pharmacia
tives boil down to three choices: the evaluation of comparable assets sold in the
transaction.
rules aren't likely to
hold Pfizer management any more accountablefor the success or failure of the
merger than the
pooling method did.
Even if Pharma-
have less unrecognized intangible value
or becausethey may set up the acquired
business asa stand-alone unit, will have
a greater risk of impairment charges
down the road-and quite likely problems with investors. At large companies,
on the other hand, the acquired company would have to plummet in value be-
market, the cost of replacing the collection of assets, or the present value of expect-
BIGGER
IS BETTER
The upshot ofFAS 142's allocation rules
is that large companies with multiple
businessunits and little existing goodwill
have an advantage over smaller companies in the acquisition market. If the value of acquired assetsfalls in the future,
smaller companies, either becausethey
32
CFO I OCTOBER 2002
ed future cash flows from the assets.
Whichever method a company chooses, it has to apply it consistently for all
future reviews. "If a company writes down its goodwill to fair value and its business
prospects continue to decline,
it will have more impairments down the road," says
Mark McDade, a partner at PricewaterhouseCoopers.
And after this year, the occur-
rence of impairment charges to goodwill, regardless of their size, will likely have a
lot more negative impact in the market. + A.D.