Companies using the merger accounting method adopted in many recent bank deals have been turning out subpar returns for shareholders, a study indicates.
In a review of U.S. bank and nonbank mergers worth more than $1 billion, a New York-based management consulting firm found that companies accounting for their deals as poolings of interest failed to beat similar companies' performance 78% of the time.
But companies that accounted for their acquisitions as purchases outperformed their peers 52% of the time during the three-year period examined, Mitchell Madison Group found.
Banks and other companies have turned to the pooling method in part because it is easier to sell deals to shareholders when the premium paid for the acquisition need not be deducted over time from earnings.
In practice, according to Mitchell Madison, the less stringent accounting appears to have led to lax management.
"Purchase accounting provides management the incentive to rebuild earnings," said Kenneth W. Smith, a partner in charge of Mitchell Madison's M&A research program. "With poolings, the same level of urgency isn't there, nor may post-merger managements feel the same level of accountability."
The findings are especially relevant for investors in banking companies. Since September, 257 bank mergers have been accounted for as poolings and 144 have been purchases, according to Sheshunoff Information Services. That's a drastic change from 1996, when only 121 mergers were poolings and 262 were purchases.
In purchase deals, the price paid above a company's net worth-called goodwill-is deducted from the buyer's reported earnings per share for many years. For example, Mellon Bank Corp., which almost always uses purchase accounting, reported second-quarter earnings of 81 cents per share on a diluted basis but 91 cents per share when the goodwill from its acquisitions is accounted for.
In a pooling transaction, the two companies' balance sheets are combined-or pooled-without revaluing the historical costs of the firm's assets. Because no goodwill is involved, the merged company's reported earnings look "cleaner."
But a cleaner balance sheet does not necessarily make for a more vibrant company, Mr. Smith has found. Within three years, companies that pool generally provide inferior returns to shareholders than companies that try to dig their way out of the goodwill. Only 22% of these companies outperform their peers.
Thomas F. Theurkauf, a bank analyst at Keefe, Bruyette & Woods Inc. who has studied how bank stocks have performed after mergers, said he was not surprised by the notion that shareholders fare better after purchase transactions.
One important benefit of purchase deals, he said, is that companies are free from the capital restrictions spelled out by the Securities and Exchange Commission. For example, a company that is accounting for a recent merger as a purchase may buy back its stock from shareholders, but a company using the pooling method may not.
"Purchase allows you to work your capital more, which is almost always to the company's betterment," Mr. Theurkauf said.
Mellon Bank, one of banking's best-performing stocks, has used purchase accounting for every acquisition except Dreyfus Corp. Spokesman Greg Stein said the banking company explores doing every deal as a pooling, but that the SEC's restrictions make it difficult for the bank to manage its capital as it would like.
These SEC restrictions have not discouraged Mellon's competitors from doing poolings more often, however. NationsBank Corp., for example, used pooling accounting when it bought Barnett Banks Inc. in January after using purchase accounting when it bought Boatmen's Bancshares in 1997.
Investment bankers say companies shy away from purchase accounting nowadays in large part because mergers have grown more expensive and would require taking on enormous amounts of goodwill.
If a stock buyback is not imminent, they argue, cluttering the balance sheet with goodwill isn't nearly so comforting as a pooling of interests.
Which is just what concerns people like Mr. Smith, who says, "Pooling is a recipe for complacency."
