Separating Fact From Fiction

BY WILLIAM M. VANDENBURGH

I believe the article, “Everyone Out of the Pool” ( JofA, May00, page 45) , overlooked several significant issues and that its examples contained some debatable points.

The authors concluded that companies generally pay a premium to complete a merger by the pooling method. According to the article, companies that rush to use the pooling method before the FASB’s proposed elimination do so at the expense of shareholders. Unfortunately, the research failed to consider many factors and, as a result, had several questionable implications.

The article strongly implies that Pfizer paid at least an 8% pooling-price premium in its merger with Warner Lambert. In reality, little or none of the price paid was attributable to the pooling method. The premium paid was due to a heated takeover battle. Pfizer was determined to acquire Warner Lambert at almost any cost due to the blockbuster drug Lipitor.

The article then cited the AOL and Time Warner merger as a case in which a company elected the purchase method and avoided paying a price premium. It said analysts would see through reported earnings charges and look at cash earnings. Nowhere did the authors mention that prior entertainment deals had been completed that reduced earnings.

Goodwill is the crucial amortization expense that is incurred when using the purchase method. Industry-specific characteristics probably played a large role in the use of the purchase method.

Finally, the advantages of share buybacks are touted as another disadvantage to the pooling method. While the announcement of a buyback program often temporarily raises a stock’s price, the long-term effect is less clear. Many companies announce buybacks that not only last several years, but also are never fully completed. Few of the buybacks announced after the 1987 crash were completed. Many times the shares repurchased replaced only shares issued through employees’ stock options (Standard and Poor’s, 6-14-00). Even the tax advantage of share buybacks is a “wash,” considering that a pooling transaction is nontaxable.

Based on the examples cited, one could make compelling arguments against the authors’ conclusions. Shareholders may not be paying pooling purchase premiums. If, as the efficient market theory strongly implies, the market sees through the reported earnings, it should also see through the structure of the deal. It is contradictory to imply the market is efficient with respect to earnings but inefficient with respect to the structure of a deal.

William M. VanDenburgh
Baton Rouge, Louisiana

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