Separation Anxiety

Will FAS 141 have some managers rethinking their acquisition strategies?

Generally speaking, CFOs are quick to dismiss any notion that the Financial Accounting Standards Board’s recent issuance of Statement 141, Business Combinations, might possibly alter their companies’ acquisition strategies. And on first blush, the standard’s call to end goodwill amortization for all deals completed after June 30 would not seem to alter the urge to merge. After all, the acquired asset is a noncash item, and a company’s valuation methodology often uses a discounted cash flow analysis.

Nevertheless, one provision of FAS 141 — the required separation and valuation of certain acquired intangibles from goodwill — has Martin Headley, CFO of Roper Industries, expressing concern. “I think what came as something of a surprise was the wide range of intangible assets FASB mandated had to be valued,” Headley says. That range, he adds, “makes it a very extensive exercise — and a new exercise.”

Roper, a maker of industrial control and analytical products, will adopt FAS 141 and FAS 142 (Goodwill and Other Intangible Assets) at the start of its fiscal year, November 1. But with Roper’s $151 million purchase of Struers Holdings A/S on July 30, Headley is now required under FAS 141 to immediately break out the acquired intangible assets from goodwill.

That’s no easy task for Headley’s staff or Struers’s management, which now has to develop reserves of intangible asset — reserves they were not accustomed to developing in the past. “That’s a burden I’d rather not see because the management is going through implementation and closing out the transaction,” notes Headley. “And it’s an additional burden for us to monitor and direct it.”

Once intangible assets are recognized separate from goodwill, CFOs and their valuation advisors are required to determine the useful lives of those assets. If it’s finite, as in the case of patents and backlog, the intangible asset will be amortized over its lifetime. During the first year of adoption, companies record the charge as a change in accounting. Beyond that timeframe, however, charges are recorded as operating expenses, a hit to earnings.

Intangibles such as brand names and trademarks that may have no determinable life — like goodwill — do not have to be amortized. They are held on the books until an impairment test proves otherwise. That procedure, however, has breathed new life into the age- old accounting question: Does EPS matter?

If cash flow is king, as so many CFOs say, EPS should not matter. But their actions belie their words.

“What is becoming crystal clear is CFOs are vitally concerned about reported earnings,” says Alfred King, chairman of consultancy Valuation Research. King says finance chiefs are “fighting tooth and nail” to get intangibles into goodwill or accounted for with an indefinite life. “But if EPS has no impact,” King wonders, “why are they fighting so hard?”

King cites the example of one client which is in the middle of completing an acquisition. “They have not closed the deal yet,” he says, “but they are already recognizing that the intangibles have a short life. It’s giving them heartburn.” And while identifiable intangible assets are not enough to kill the deal, he says, the threat of earnings dilution from intangible asset amortization could be enough for the buyer to negotiate a lower price.

Some CFOs conceded that dilution from intangible asset amortization is a consideration when purchasing. “When you announce an acquisition, you talk to investors about accretion or dilution and part of that is whether you have intangibles and the type of charges through the P&L,” says Mary Kabacinski, CFO at School Specialty. “If you’re sensitive to extreme dilutions that might be created from intangible asset amortization, maybe it effects [your] decision to buy the target.”

Wall Street’s investment bankers appear to support the notion that EPS does indeed matter. “Public companies, and even IPOs of companies, are often priced by analysts as a multiple of earnings per share, not cash flow,” says Doug Rogers, executive vice president at CBIZ Valuation Counselors. “It is a myth to believe that the accounting change has had little if no effect on deal making.” Rogers notes that many of CBIZ’s clients “are asking us to view acquisitions based on the old allocation rules versus the new rules, under which intangibles with indefinite lives and goodwill are no longer amortized.”

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