VideoFor myriad business reasons, companies that plan to merge usually make it abundantly clear which company is the acquirer and which is the target. But the designations take on additional importance when examined from an accounting perspective. Consider that for an acquiring company, the consolidated, post-combination financial statements represent the "continuation" of the company's results, and reflect the assets and liabilities at their pre-combination amounts. Meanwhile, the assets and liabilities of a target company are recognized and measured under guidance provided in FAS 141(R), Business Combinations, at their acquisition date fair market values.
In the case of a business combination completed wholly, or at least primarily, through an exchange of equity interests — like the one recently announced by CenturyTel Inc. and Embarq Corp. — the identity of the acquirer is not always readily apparent. That's a problem because the affect of the business combination on post-combination earnings will, to a large degree, be influenced by the proper identification of the acquirer and the acquiree. Indeed, it is only the latter's assets and liabilities that are recorded using a new basis of accounting.
On October 27, CenturyTel and Embarq, two regional local phone companies, announced that their respective boards approved a definitive agreement under which CenturyTel, by means of a reverse triangular merger, would acquire Embarq in a tax-free stock-for-stock transaction.
By structuring the union as a reverse triangular merger, a newly-created subsidiary of CenturyTel will be merged with and into Embarq. Further, the transaction's claim to tax-free treatment is ironclad, as the merger will constitute a reorganization under the tax code. (Specifically under Section 368(a)(1)(A) by reason of Section 368(a)(2)(E)).
Embarq is by far the larger of the merger partner. Accordingly, the merger agreement notes that for each common share of Embarq, its stockholders will receive 1.37 shares of CenturyTel common stock. When the transactions closes, Embarq shareholders are expected to own approximately 66 percent of the combined company, while CenturyTel shareholders will own about 34 percent, according to the companies.
Nevertheless, CenturyTel chairman and CEO Glen Post will retain his position with respect to the combined company, and following the closing of the transaction, the board of directors of the merged company will comprise eight current CenturyTel board members and only seven members from the current Embarq board.
Ordinarily, in a business combination that is based wholly or primarily on an exchange of equity interests, the acquirer is the company that issues equity in the transaction. Following this general rule, CenturyTel would be viewed as the acquirer.
Under FAS 141, however, so-called reverse acquisitions are viewed under a different light. In a reverse acquisition, an issuing entity (CenturyTel in this case) is properly classified as the acquiree. In making this determination, FAS 141 requires the parties to consider (in addition to the identity of the issuing entity) several other factors — although the rule does not specify the relative weight to be accorded to each of the factors. Thus, financial statement preparers are left to apply their own judgment regarding the importance they give to one factor over another.
Factor Analysis
The factors enunciated in FAS 141 are as follows:
• The relative voting rights in the combined company after the business combination. The acquirer usually is the company whose owners, as a group, retain or receive the largest percentage of the voting rights. Clearly, this factor points to Embarq as the acquiring entity.
• The existence of a large minority voting interest in the combined company if no other owner or "organized group" has a significant voting interest. The acquirer usually is the company that has a single owner or organized group that holds the largest minority voting interest. The factor in this case appears to be neutral.
• The composition of the governing body of the combined entity. The acquirer usually is the company whose owners have the ability to elect or appoint a majority of the members of the governing body. In this case, at least initially, a majority of the governing body of the combined entity will be comprised of former CenturyTel board members.
• The composition of the senior management of the combined entity. The acquirer usually is the company with former management that dominates the management of the combined company. It would seem that this factor clearly points to CenturyTel as being the acquirer.
• The terms of the exchange. Ordinarily, the acquirer is the company that pays a premium over the pre-combination fair value of the equity interests of the merger partner. This factor too seems unmistakably to point to CenturyTel as the acquirer.
• The acquirer usually is the combining company with a relative size (measured, for example, in terms of assets, revenues, or earnings) that is "significantly larger" than that of its merger partner. This factor falls squarely on the side of Embarq's claim to status as the acquirer.
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