Talk about a win-win deal.

Kellogg’s $4.3 billion acquisition of the Keebler product line will likely prove both a hit with investors and a home run from the accounting point of view.

With yields at a low recently, the cereal giant, which has not issued a bond in more than two years, stands a good chance of obtaining favorable financing.

But that is corn flakes compared to the paper windfall Kellogg stands to gain as a result of anticipated changes in GAAP treatment of the acquisition, which will cause the firm’s reported earnings to rise more than 30 percent.

The change will add $150 million annually to Kellogg’s earnings.

Officials at Kellogg say they hope to close both the merger and the $4 billion bond offering either on or around March 26.

New Rules to Take Effect

With the comment period on FASB’s new rules for goodwill accounting having passed on March 16, chances look good that new accounting principles eliminating pooling of assets in acquisitions and eliminating the amortization of goodwill will take effect in July.

Analysts and critics predicted that the new rules would greatly improve the climate for hostile and cash acquisitions.

But regulators in the U.S.–both from FASB and the SEC–are saying that the new rules are needed because they make economic sense and they go a long way toward eliminating discrepancies between U.S. GAAP and International Accounting Standards.

Kellogg’s Keebler acquisition, which was announced in October 2000, is a classic illustration of the kinds of deals that spawned the discussion and altering of the rules that govern goodwill, or that part of an acquisition’s value that cannot be attributed to balance sheet items.

In addition to manufacturing facilities and other tangible assets and liabilities, Kellogg is also purchasing a brand name — Keebler — for which the consuming public has largely formed an image.

As of now, firms that have already done acquisitions must amortize the “goodwill” component of the deal, producing a significant drain on earnings, typically for 20 to 40 years.

But under the new rules, this requirement will probably be eliminated retroactively, meaning that Kellogg and other firms with acquisitions that are still not completely amortized stand to receive a hefty jump in earnings, albeit one with a footnote and no effect on EBITDA or actual cash flows.

Under the new system, Kellogg would not be required to take a charge against goodwill unless the brand name had actually been impaired.

New Breakeven Point

Kellogg’s acquisition of Keebler is actually being accomplished through the firm’s purchase of Flower Industries’ controlling interest in Keebler Foods for $42 per share. Counting the value of debt Kellogg would assume from Keebler, the cost of the deal runs to over $4.3 billion.

Simultaneously, Flowers Industries will spin off its remaining assets — Mrs. Smith’s Bakeries and Flowers Bakeries — into a new publicly held company, to be called Flowers Foods.

A proxy statement released by Kellogg after the deal had been reached last fall shows that while a positive cash flow will accrue to the purchaser within the current year, it will take until the 2004 fiscal year before the acquisition has a positive effect on earnings.

During the current year, the firm estimates that the deal will subtract $0.36 from reported earnings per share, which have most recently been reported at $1.23.

Most of this drain is due to the effect of goodwill amortization.

While the deal has not yet been finalized and a definite book value for the acquired assets has not been publicly released, goodwill amortization for this year and next has already been forecasted at $0.37 per share.

With 405.6 million shares outstanding, this puts the annual tab for goodwill amortization at about $150 million.

Take away this “cost” and the acquisition will add a penny to the earnings of each share in 2001. This figure becomes $0.33 in 2004, as “synergies” envisioned by the merger take hold, according to the proxy.

Company officials say they are unable to comment until after the deal is finalized.

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