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Many companies and Wall Street analysts cheer the new accounting rules governing mergers and acquisitions taking effect in December. The new rules eliminate the requirement to amortize goodwill on acquisitions made at least partly with cash. Goodwill charges have often had a nasty habit of making acquisitions dilutive. Take Procter & Gamble Co.’s $4.95 billion acquisition of Clairol last week: The company said the deal is dilutive to P&G’s earnings in the first year by 6 cents to 8 cents per share. But P&G’s CFO, Clayton Daley, says under the new Financial Accounting Standards Board rules, the deal would have been immediately accretive. FASB will allow companies to stop amortizing existing goodwill on their books after Dec. 15. The new rules eliminate the amortization of goodwill, the difference between the purchase price and the fair market value of the company’s assets. Under existing accounting rules, companies must steadily write off the value of goodwill in an acquisition for up to 40 years, just as they must take depreciation charges on their real estate, machinery and equipment. Before everyone rejoices over the end of the bad old days of goodwill amortization, M&A accounting experts warn it may not be quite that simple. While companies no longer must take automatic goodwill charges every year, the new FASB rules require companies to account for identifiable intangible assets, and in some cases may require companies to amortize their cost over time. Identifiable intangible assets include brands, trademarks, patents and customer lists. Some M&A experts say the jury is still out on whether companies will have to amortize brands, a major part of the value in any company that lives off its recognizable brand names. “It’s hard to say what will be an identifiable intangible with a finite life, says Robert Filek, M&A adviser to consumer products companies at PricewaterhouseCoopers. “There will be a lot of discussion on this and FASB or the SEC [Securities and Exchange Commission] may come out with further guidance on the subject. “If it determines that a brand name is like good will, then companies will not have to amortize it.” Most M&A accounting experts argue brand names, and other intangible assets such as customer lists, don’t have a finite life and should not have to be amortized, and expect FASB to come down on that side of the issue. Says Robert Willens, an M&A tax adviser at Lehman Brothers Inc., “It’s really important where FASB classifies a brand name. Is it goodwill or a separate identifiable intangible asset? — in which case it would have to be amortized.” “If they said a brand is an identifiable intangible asset that would shock me.” Even if an intangible asset must be accounted for separately from goodwill, it will not have to be amortized if it is determined to have an indefinite life. “What people are forgetting is that certain identifiable intangible assets with an indefinite life wouldn’t have to be amortized,” says Kim Petrone, manager of FASB’s business combinations project. She said companies will have to determine which intangible assets have indefinite lives, based on FASB’s new rules. It could be a hot-button issue for FASB. One question is who can put a finite life — one of FASB’s criteria for identifiable intangible assets that need to be amortized — on a brand name? “In a consumer product company, what creates value is a multitude of factors not subject to legal agreements or time limits, as the case with a patent,” Filek says. For Alfred King, chairman of Valuation Research, a New York firm that appraises potential acquisitions for buyers, brands are pretty clearly one of those items FASB wants companies to amortize under the new rules. “Everyone I’ve talked to would suggest trade names and brand names are identifiable intangibles,” King says. “One of the criteria FASB has said should be used to determine if something is an identifiable intangible asset is, ‘Can you sell it separately?’ With brands the answer is absolutely yes.” Nonetheless, the biggest food and beverage companies expect burdensome goodwill amortizations to vanish with the new accounting rules, says William Leach, analyst at Banc of America Securities. “I think the new accounting rules will encourage more deals. The valuation of many food companies are low, and if it weren’t for goodwill charges, which wreck these companies’ reported earnings, there would be more M&As.” The way stock investors have reacted to goodwill charges has been about as illogical as the charges themselves, Leach says. If goodwill charges are more than 25 percent of a company’s earnings, the market ignores them, but if they’re under that, the market is more likely to look at a company’s reported earnings, which include the charges, he says. Goodwill has cut into the earnings of companies that made some of last year’s large acquisitions in the industry — goodwill charges on the Philip Morris Cos. acquisition of Nabisco last year trimmed its earnings per share to $1.10 from $1.65 per share excluding goodwill charges. Even if most branded consumer product companies won’t have to put brand names into goodwill, that won’t mean goodwill will disappear for good. The new rules call for annual impairment tests, in which companies must compare the fair market value of goodwill and intangible assets, such as brands, with the value recorded on their books. If the fair market value of an acquisition goes down, the company will have to take charges against earnings. Besides subjecting acquisitions to such testing, companies will have to perform such tests on the units that make up the acquired company. If companies must dice up goodwill, brand values and numerous other intangible assets among various reporting units, it’s going to be harder to hide the wear and tear on such assets. King, who recently completed a valuation analysis of brands Philip Morris bought in the Nabisco deal, says the new rules will encourage companies to maintain marketing and advertising support for acquired brands or risk taking impairment charges. “For example, with Nabisco, it’s unlikely that Ritz or Oreo will go down in value. But second-tier brands in Nabisco might,” King says. “No company has unlimited resources. As they put less marketing behind some brands, there are going to be some cases where the company has to write down the value of their brands.” While putting a fair market value on brand names may seem arbitrary, King says there’s a scientific way of doing it — and anyway companies have been doing it for years when they look at acquisitions. One method used to measure a brand’s market value is to examine the difference in price between a brand and a generic counterpart. “If we were asked to value Coca-Cola, we might look at the premium the company can obtain compared to a generic cola brand. Then we use a discounted cash flow analysis over, let’s say, 20 years, to determine its value today,” King says. “There are also other methods for coming up with a brand value, such as looking at the flow of licensing fees from popular brand names.” Copyright (c)2001 TDD, LLC. All rights reserved.

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