For myriad business reasons, companies that plan to merge usually make it abundantly clear which company is the acquirer and which is the target. But the designations take on additional importance when examined from an accounting perspective. Consider that for an acquiring company, the consolidated, post-combination financial statements represent the “continuation” of the company’s results, and reflect the assets and liabilities at their pre-combination amounts. Meanwhile, the assets and liabilities of a target company are recognized and measured under guidance provided in FAS 141(R), Business Combinations, at their acquisition date fair market values.
In the case of a business combination completed wholly, or at least primarily, through an exchange of equity interests — like the one recently announced by CenturyTel Inc. and Embarq Corp. — the identity of the acquirer is not always readily apparent. That’s a problem because the effect of the business combination on post-combination earnings will, to a large degree, be influenced by the proper identification of the acquirer and the acquiree. Indeed, it is only the latter’s assets and liabilities that are recorded using a new basis of accounting.
On October 27, CenturyTel and Embarq, two regional local phone companies, announced that their respective boards approved a definitive agreement under which CenturyTel, by means of a reverse triangular merger, would acquire Embarq in a tax-free stock-for-stock transaction.
By structuring the union as a reverse triangular merger, a newly-created subsidiary of CenturyTel will be merged with and into Embarq. Further, the transaction’s claim to tax-free treatment is ironclad, as the merger will constitute a reorganization under the tax code. (Specifically under Section 368(a)(1)(A) by reason of Section 368(a)(2)(E)).
Embarq is by far the larger of the merger partner. Accordingly, the merger agreement notes that for each common share of Embarq, its stockholders will receive 1.37 shares of CenturyTel common stock. When the transactions closes, Embarq shareholders are expected to own approximately 66 percent of the combined company, while CenturyTel shareholders will own about 34 percent, according to the companies.
Nevertheless, CenturyTel chairman and CEO Glen Post will retain his position with respect to the combined company, and following the closing of the transaction, the board of directors of the merged company will comprise eight current CenturyTel board members and only seven members from the current Embarq board.
Ordinarily, in a business combination that is based wholly or primarily on an exchange of equity interests, the acquirer is the company that issues equity in the transaction. Following this general rule, CenturyTel would be viewed as the acquirer.
Under FAS 141, however, so-called reverse acquisitions are viewed under a different light. In a reverse acquisition, an issuing entity (CenturyTel in this case) is properly classified as the acquiree. In making this determination, FAS 141 requires the parties to consider (in addition to the identity of the issuing entity) several other factors — although the rule does not specify the relative weight to be accorded to each of the factors. Thus, financial statement preparers are left to apply their own judgment regarding the importance they give to one factor over another.