New Merger Rules May Spark Cash Deals

Managements may want to tweak deal structures and due diligence in light of new accounting rules.

New accounting rules may affect the structure and timing and timing of mergers. As a result, companies will have to rethink how much equity or cash to plow into a deal, what kinds of share-price restrictions to apply, and when’s the best time to close a transaction.

The rules, two released by the Financial Accounting Standards Board in December, and two companion mandates issued by the International Accounting Standards Board last week, affect companies both in the United State and abroad. But American companies using U.S. generally accepted accounting principles will likely be affected to a greater extent because the most sweeping changes were made to the American body of rules.

For example, under FAS 141(R), Business Combinations, which will be in effect for acquisitions that close in fiscal years that start after December 15, 2008, buyers must value the amount paid for a target company on the day the transaction closes, rather than the day of the deal announcement, which is current practice. That includes recording the value of stock the buyer may use to pay for all or part of an acquisition.

But transactions can take months, or even a full year, to finalize, and a lot can happen to a buyer’s share price during that time, says John Formica, a partner with PricewaterhouseCoopers. In the absence of any price protections, the new accounting treatment could make the use of equity in an M&A deal less attractive, Formica told CFO.com.

If stock is used to pay for the acquisition, the final purchase price, as well as its potential affect on earnings, will not be fully known until the deal is inked. “From a measurement perspective, [dealmakers] will want to sign and close as quickly as possible” unless a collar is put in place to assure that more money is not being spent on the deal than is necessary, says Barry Smith, managing director of SMART Business Advisory and Consulting.

Consider a transaction in which the buyer’s stock price rises, increasing the value of the shares allocated to the deal. That could result in more goodwill and, therefore, more goodwill impairment risk in future periods. For example, say that a large food conglomerate with a stock price of $25 per share announces a deal to buy a small ice cream producer for $30 million, or 1.2 million shares. Nine months later—in a typical deal timeframe—the transaction closes when the buyer’s share price is $26.

So although the same number of shares will be used to complete the transaction, the buyer is paying a $1.2 million premium for the target, which will typically be accounted for as goodwill.”The goodwill could be in excess of what is [considered market value], and that could mean a hit to your profit and loss statement,” says Smith. For instance, there would be pressure to perform a goodwill impairment assessment, which at some point may force the buyer to write down the $1.2 million premium and take a hit to earnings.

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