Merger Accounting Changes To Eliminate Higher Earnings and Share Price Growth Offered By Pooling Method

Business Wire, July 27, 1999

MINNEAPOLIS--(BUSINESS WIRE)--July 27, 1999--

Companies utilizing the pooling method of accounting for merger transactions had stock prices one year later that were on average 15.7 percentage points higher than companies using the purchase method, according to a new study just released by U.S. Bancorp Piper Jaffray.

For the study, U.S. Bancorp Piper Jaffray analyzed all transactions over the past 10 years for which there was one full year of post-deal earnings information and stock price performance. As of year-end 1998, there were 27,500 transactions that met these criteria. After excluding foreign acquirers, financial firms, transactions involving less than 100 percent change of control and deals with incomplete information, a data set of 8,677 transactions remained.

The data show clearly the impact of using pooling versus purchase accounting on both post-deal earnings and stock price performance. Companies using the pooling method reported earnings per share growth one year later averaging 21.1 percent, compared to 13.6 percent for companies using the purchase method. The stock of companies utilizing pooling showed a return of 9.1 percent over that of the Standard & Poor's 500, while that of companies using purchasing underperformed the Standard & Poor's 500 by 6.6 percent. In a pooling transaction, there is no recognition, or subsequent amortization, of goodwill. Goodwill is the premium paid over the fair market value of assets acquired.

"It's clear that the market rewards the higher earnings per share generated by companies utilizing the pooling method of accounting," stated Daniel J. Donoghue of U.S. Bancorp Piper Jaffray, the principal author of the study. "While it seems inconsistent with modern economic theory, these statistics support acquirers' claims that the earnings per share dilution caused by goodwill hurts their stock price."

U.S. Bancorp Piper Jaffray undertook the study in advance of a major accounting rule change expected to be formally announced later this summer from the Financial Accounting Standards Board (FASB), which will include suggested changes to purchase and pooling accounting. It is expected that the pooling-of-interests method of accounting will be eliminated and that the amortization period for goodwill recognized under the purchase method will be reduced from a maximum of 40 years to 20 years.

The FASB report comes at a time when merger and acquisition activity is at an all-time high. The last three years in particular have seen a substantial increase in merger and acquisition transactions, with the number of deals jumping from about 3,500 in 1995 to nearly 8,000 in both 1997 and 1998, according to Mergerstat Review.

Donoghue notes that, given the market's view toward goodwill, these changes may have a dampening effect on merger and acquisition activity. "Some acquisitions that make sense from a business and cash flow perspective have hinged upon the ability to obtain pooling treatment and thereby avoid the earnings drag from goodwill," Donoghue said.

The U.S. Bancorp Piper Jaffray report concludes that the overall level of reverberation in the market is likely to be minimal given the fact that the majority of transactions are already accounted for under the purchase method of accounting. Of the 8,677 transactions examined, 8,203, or 95 percent, used the purchase method. Pooling was used in 474 transactions, or five percent. However, pooling tended to be used in the larger, public market transactions while purchase accounting was favored in smaller, private market deals. The purchase deals had a mean transaction size of $125 million versus almost $300 million for the pooling deals.

For a complete copy of report, please contact Joy Walter, U.S. Bancorp Piper Jaffray, 312/920-2131.

U.S. Bancorp Piper Jaffray, a subsidiary of Minneapolis-based U.S. Bancorp, provides a full range of investment products and services to businesses, institutions and individuals. The company's investment banking business has grown exponentially in the last several years by focusing on the needs of growth companies in the consumer, financial institutions, health care, industrial growth and technology growth sectors. U.S. Bancorp Piper Jaffray has a national reputation for its expertise in equity research and both equity and debt financing. U.S. Bancorp offers a comprehensive range of financial solutions through U.S. Bank, First American Asset Management, U.S. Bancorp Libra Investments and U.S. Bancorp Piper Jaffray. For more information, visit our Web site at www.piperjaffray.com.

Nondeposit investment products are not insured by the FDIC, are not deposits or other obligations of or guaranteed by U.S. Bank National Association or its affiliates, and involve investment risks, including possible loss of the principal amount invested. Securities products and services are offered through U.S. Bancorp Piper Jaffray Inc., member SIPC and NYSE, Inc., a subsidiary of U.S. Bancorp.