The factors enunciated in FAS 141 are as follows:
• The relative voting rights in the combined company after the business combination. The acquirer usually is the company whose owners, as a group, retain or receive the largest percentage of the voting rights. Clearly, this factor points to Embarq as the acquiring entity.
• The existence of a large minority voting interest in the combined company if no other owner or “organized group” has a significant voting interest. The acquirer usually is the company that has a single owner or organized group that holds the largest minority voting interest. The factor in this case appears to be neutral.
• The composition of the governing body of the combined entity. The acquirer usually is the company whose owners have the ability to elect or appoint a majority of the members of the governing body. In this case, at least initially, a majority of the governing body of the combined entity will be comprised of former CenturyTel board members.
• The composition of the senior management of the combined entity. The acquirer usually is the company with former management that dominates the management of the combined company. It would seem that this factor clearly points to CenturyTel as being the acquirer.
• The terms of the exchange. Ordinarily, the acquirer is the company that pays a premium over the pre-combination fair value of the equity interests of the merger partner. This factor too seems unmistakably to point to CenturyTel as the acquirer.
• The acquirer usually is the combining company with a relative size (measured, for example, in terms of assets, revenues, or earnings) that is “significantly larger” than that of its merger partner. This factor falls squarely on the side of Embarq’s claim to status as the acquirer.
Taken together, some factors point to CenturyTel as being the acquirer. For example, CenturyTel is the issuing entity, it is paying a premium to Embarq shareholders, and its loyalists will comprise a majority of the governing body and senior management of the combining company.
Yet concurrently, there are persuasive factors supports a claim by Embarq as being the acquirer, including the fact that its shareholders emerge with the largest percentage of the voting rights, and that Embarq is by far the dominant constituent with regard to its relative size. All the same, it is our view that in the final analysis CenturyTel will emerge as the acquirer in this business combination.
Oddly, this resolution of the issue seems to give rise to a greater “basis step-up” — and therefore a larger post-combination non-cash charge and correspondingly lower earnings — than would be the case if Embarq was identified as the acquirer. Witness the situation if Embarq was identified as the acquiring company in a reverse acquisition. In that case, the acquisition date fair value of the consideration transferred by the acquirer is based on the number of equity interests the “legal subsidiary” (Embarq) would have had to issue to give the owners of the “legal parent” (CenturyTel) the same percentage equity interest in the combined entity.
It appears, then that Embarq would be viewed as issuing some 77 million shares. And depending on where the stock price sits at the effective date of the business combination, the value of these hypothetically issued shares might even fall below the net fair value of the legal parent’s assets. Accordingly, if this business combination was accounted for as a reverse acquisition, “negative goodwill” might arise. In addition, the negative goodwill would be included in earnings for the period in which the business combination takes place.
If however, as we expect, CenturyTel is identified as the acquirer, an increase in the carrying amount of Embarq’s assets is likely to ensue. That would result in the earnings of the post-combination company being penalized by the need to depreciate and amortize those higher values — as opposed to the pre-combination amounts reflected on Embarq’s financial statements.
In any event, given the subjective nature of the determination, a case can be easily made for labeling either constituent as the acquirer. Therefore, the post-acquisition earnings impact of the transaction might, in some sense, be regarded as unduly within the discretion of management and their advisers.
Contributor Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for CFO.com.