Accounting & Tax

Commission’s Guidance Puts Damper on Leveraged Recaps

Public share prices may be down, but the leveraged-buyout crowd isn't exactly jumping at bargains.
Andrew OsterlandOctober 11, 2001

Public share prices may be down, but the leveraged-buyout crowd isn’t exactly jumping at bargains.

One reason could be new guidance from the SEC on accounting for leveraged recapitalizations. Per Staff Accounting Bulletin 54, if corporate or financial buyers acquire more than 94.9 percent of a company, they have to write up the target’s assets to fair market value–commonly called pushdown accounting. For buyout groups hoping to eventually bring the company back to the public market, lower asset values and depreciation charges make for a better IPO road show in the future– even with FASB’s new rules on goodwill. The SEC announcement at the April meeting of the Emerging Issues Task Force, however, could make it more difficult to avoid the step-up in asset values. “I know a lot of people who, if they can’t do a recapitalization, won’t do the deal,” says Mark McDade, transition services partner at PricewaterhouseCoopers.

The trick to qualifying for favorable accounting treatment is to find an independent minority investor–emphasis on independent–to hold at least 5.1 percent of the firm’s stock. The SEC has suggested that it will look more closely at the contracts between investors in a buyout group to ensure that the minority investor is in fact not part of a “collaborative group,” in which case pushdown accounting would be required.

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What constitutes independence? The minority investor cannot have any affiliations with the other investors, can’t solicit other parties to invest in the deal, and must be free to exercise its voting rights and sell the shares. It also has to fully participate in the risks as well as rewards of ownership. That means it has to invest on the same terms as other investors, and that its return is in no way guaranteed. It’s not unusual for minority investors in leveraged recaps to have their losses limited by put or call options negotiated with the buyout group.

Just what will fly with the SEC? “It’s difficult to tell which facts and circumstances will break the camel’s back,” says McDade. Apparently, buyout artists aren’t eager to find out.

SUMMER RECAP

Recent leveraged recapitalizations by nonfinancials.

  • June 28: TransWestern Publishing — $900 million
  • July 2: InSight Health Services — $500 million
  • August 8: Springs Industries — $650 million

Source: Thomson Financial