Draining the pool: Accounting changes may affect price, pace of telecom mergers

Time may be running out for an accounting method that has made possible some of the largest telecom and Internet mergers of the last few years.

The Financial Accounting Standards Board, a non-governmental agency that lays down the rules for corporate accounting in the U.S., has proposed ending by Jan. 1, 2001 the pooling of interest method of evaluating corporate acquisitions. The proposal will undergo months of comment before a vote early next year.

Pooling of interest treats combining companies as if they never existed separately. Many of telecom's biggest recent combinations have used the method: WorldCom's acquisition of MCI, SBC Communications' purchase of Ameritech, America Online's purchase of Netscape Communications and Lucent Technologies' Ascend Communications buy.

But many technology acquisitions are not mergers of equals. The acquired company may be poor in tangible assets but rich in intangibles, ranging from patents, trademarks and undeveloped technologies to customer lists, Web hits and technicians.

The alternative to pooling, the purchase model, figures the difference between a target company's hard assets and the price the acquiring company pays for it, labeling that difference goodwill. This goodwill is counted as part of the cost of combining and is paid off from revenues bit by bit, just like the cost of a factory. That cost stays on the new company's balance sheet for years, driving down net earnings and affecting stock price.

FASB says the purchase method gives a truer picture of the actual cost of an acquisition and helps investors sort the valuable combinations from the overpriced.

But opponents say the change will penalize industries in which today's intangible can be tomorrow's - or even this afternoon's - killer app.

"If I couldn't write down Cerent, I would not have bought the company," said John Chambers, president and CEO of Cisco Systems, referring to Cisco's intended purchase of optical transport maker Cerent. "I wouldn't want to carry that additional charge against my earnings for the next five years." Without the ability to pool interests, Chambers added, Cisco probably would not have acquired half the companies it has in the last few years.

"Pooling was meant for combinations among companies of equal size," said John Palumbo, a senior analyst with Reiner-Meeks Investments. "These days, those mergers are few and far-between. When a big company pools interests with a small target company, it's simply hiding the true cost of the purchase. It's a deal with Monopoly money."

Even some supporters admit that in the new knowledge economy, valuing assets is a guessing game that present-day accounting may not be equal to. "How do you assign a cost to something like a software team and then demand that it be amortized in 20 years?" asked Jack Kelty, a researcher with the Union for Financial Oversight.