By Randall Osborne

Editor

After the Financial Accounting Standards Board (FASB) voted last April to eliminate the pooling-of-interests accounting rule at the end of this year, some analysts expected biotech firms to hurry along their mergers and acquisitions, and maybe plan to seal their deals before the rule change takes effect.

But what seemed due to become an "everybody into the pool" situation has turned into nothing of the kind. Instead, analysts say, companies mulling mergers and acquisitions are testing the water carefully, and making decisions with other factors in mind.

Although the value of mergers and acquisitions soared in 1999 to $19 billion (as compared to $5.8 billion the year before), the number of them fell to 73, which is the same number as 1997.

"Until I know for sure it won't hurt us, I'm against [doing away with pooling]," said Richard Pops, CEO of Alkermes Inc., who will testify this week at the second round of hearings in New York.

The seven-member FASB voted unanimously to do away with pooling, which lets two merging companies simply add the book value of their net assets. Pooling can lead to overpayment of an acquisition, and profiling a deal afterward is impossible by inspecting the paperwork, the FASB said.

Purchase accounting, the alternate method, calls for recording assets and liabilities at fair market value, with the amount above that written off as "goodwill" from the buyer's earnings over time, thus giving a more accurate picture of the company's growth, according to the FASB.

But pooling has been much preferred in biotech transactions. For example, the $330 million merger last month of PE Biosystems with privately held genomics specialist Third Wave Technologies Inc. in an all-stock transaction was a pooling-of-interests deal.

Hearings on the rule change began in San Francisco last week, with testimony from digital companies and financial institutions "an all-star Silicon Valley cast," said David Colton, senior program manager of the Information Technology Association of America (ITAA), which wants to keep the pooling rule.

"In our industry, like [biotech], pooling of interests is very convenient," he said. "If two companies merge using pooling, they don't have to do anything with respect to how they report income for future years. But if they use purchase accounting, as in 'company A acquires company B,' that means reporting the income for the year right after the merger decreases."

Reported income continues at the lower level for whatever period is decided upon in the purchase contract, after which an "artificial bump that distorts income for investors" is shown on the books, Colton said.

Another problem, he said, is determining the amount of "goodwill" to write off in the first place, since nailing down the value of such items as brand name and intellectual property is difficult.

"In biotech and in [the information] industry, the real crown jewels are intellectual property soft things," Colton said. "Patents. Processes. Brand."

Placing a price tag on such entities is "an incredibly arcane thing, like angels on the head of a pin," he said. "That's how companies like Price Waterhouse get rich."

Colton said he understands FASB's argument that the pooling method fails to reflect the value of a merger. "We just pool the stock; nobody's acquiring anybody, technically," he said. "But the value of the pooling is reflected in the stock price of [the acquiring company]."

FASB has said it wants to establish an international standard, and most other countries agree the purchase method is best. Colton said it's mainly bureaucrats who regard the purchase method with favor, here and abroad.

Although some of the major accounting firms appreciate the complexities of the traditional purchase method, which provides them with more billing hours, Colton said they also like the pooling method's simplicity but, because many firms they serve are older and conservative, they are unlikely to say so "unless you get the guy drunk or really candid."

Pops, a board member of the Biotechnology Industry Organization (BIO), said the FASB has always "looked askance at [pooling]. But if I buy a biotech company for $200 million, and it has $40 million of book value, and $160 million of goodwill that I'm going to amortize, I'm actually buying in-process research and development that may be something and may not. Is it an asset? We don't know. It's just stuff in early clinical trials. It opens up as many questions as it attempts to solve, in our industry."

Paul Ufholz, tax counsel and director of government relations for BIO, said the situation is "negative, all the way around. Earnings are depressed over a long period of time, and that detracts from the ability to attract investors."

If the FASB goes ahead with erasing the rule, Ufholz said, "you could see a spate of mergers between that point and the end of the year."

Doug Braunstein, head of global healthcare for Chase H&Q in New York, said the pooling rule is not essential to biotech's progress, but companies might feel the pinch at first.

"The only negative, in my view, is that there may very well be a dislocation between companies that want to pursue acquisitions because they're important strategically, and the market's inability to look past cash earnings," he said. "Over a long period of time, that will go away."

Strategic acquisitions, he said, "are a critical part of almost every company's growth strategy, and the way you choose to account for that, in the end, is not going to be the determining factor in whether you pursue an acquisition. If you're not focused on goodwill, and you're focused on cash earnings, the net effect on whether you do purchase or pooling is neutral. In the near term, if the market doesn't move in that direction, then yes, [companies are] going to be affected."

Curtis Hogue, vice president and senior biotech analyst with Prudential Vector Securities in Deerfield, Ill., said the danger of restrictions brought by the pooling-rule rollback is "more a matter of perception. I don't think it makes that much of a difference, financially. Investors will still look at fundamental operating growth as a way of measuring its value."

Hogue said that, if he were running a company with a merger or acquisition as its near-term goal, he might push the deadline up.

"Assuming I could find a good transaction, it would make sense to do it now," he said. "But I wouldn't rush into something just because there was a rule."

Steven Burrill, CEO of Burrill & Co., a private merchant bank based in San Francisco, was least ambivalent of all.

"It's a bogus issue," said Burrill, who worked for 30 years as an accountant. He compared the noise made over the pooling rule to hype over Y2K.

"If two companies merge because one plus one equals three, and there's a real synergy, I don't think the pooling issue will keep them apart," Burrill said.

Analysts, he said, "have already begun to focus on cash earnings and not accounting earnings. Everybody's sensitive to earnings, and anytime you have to use purchase accounting and you have large earnings, that sounds bad. But [investors] are fundamentally looking at what the businesses are doing, and they're looking at earnings in a pretty sophisticated way."

As long as cash earnings total what the company projected, or nearly as much, all is well, Burrill said.

The pooling issue arose when American Home Products Corp. (AHP) and Warner-Lambert Co. disclosed their plan to merge in a $72 billion deal, creating the world's largest pharmaceutical company to be called AmericanWarner Inc., with a market capitalization of $145 billion.

A half day after the merger announcement, Pfizer Inc. offered to acquire all of Warner-Lambert's outstanding shares by offering $96.40 per share 2.5 shares of Pfizer stock for each Warner-Lambert share in an $82.4 billion deal.

But AHP and Warner-Lambert had granted each other cross options, and agreed to reciprocal fees of up to $2 billion upon termination of the agreement. Pfizer filed a lawsuit against Warner-Lambert and AHP seeking to enjoin the "egregious and unlawful $2 billion break-up fee and lock-up option."

Warner-Lambert's merger deal with AHP includes a provision that blocks Pfizer from acquiring it by using pooling-of-interest accounting. Pfizer had said it would only take over Warner-Lambert if pooling was used.

Colton acknowledged that the recent merger of AOL and Time Warner did not use the pooling method, but said this was only because about $15 billion in debt was assumed, and "a lot of structural reasons" prevented pooling.

"I'm sure they would have loved to do it," he added.

Because the FASB vote was unanimous, BIO's Ufholz was not optimistic about turning it around.

"Anything can happen in the legislative and regulatory process, but we've got to persuade four of those seven that this is not the way to go," he said. "If it had been 5 to 2, we'd have a pretty decent chance."

He noted that the SEC has gone on record favoring the change.

"This could be a formality," he said. "The forces are aligned against us."