In an unusual open letter from a Wall Street analyst to corporate executives, Paul Silverstein, a senior analyst at
BancBoston Robertson Stephens
, criticized Cisco's stance on a proposed change in accounting for acquisitions. Silverstein reacted to an earnings conference call held May 11, in which CEO John Chambers argued that Cisco's expansion plans might be curtailed were pooling-of-interest accounting to be abolished.
Under pooling-of-interest accounting, merging companies simply add the book values of their net assets. Were pooling to be abolished, as the
Financial Accounting Standards Board
has proposed, companies would have to use purchase accounting, in which the acquirer counts goodwill -- the premium paid over the target's fair market value -- against its earnings over time. The result can weigh down the bottom line. FASB expects to issue a final standard and make the change effective in late 2000.
Silverstein challenged Chambers' view that purchase accounting for acquisitions would create a charge to earnings in the eyes of investors. Says Silverstein: Investors are smarter than that.
"I respectfully submit that such a position shows considerable disrespect for the intelligence of your investment constituency; in short, the market -- neither buy- nor sell-side -- is not as simple as you may think," Silverstein wrote in the letter, which was steeped in a conciliatory tone. "We do not penalize companies for the charge -- i.e., we do not include the charges in our earnings model. Like you, we too only are interested in ongoing results."
The letter, dated May 14, was published on
and distributed by email Thursday afternoon to subscribers of
The First Mile
, Robbie Stephens' newsletter about the data communications industry. Silverstein says "several hundred" people subscribe to the newsletter.
Silverstein's letter is "extremely unusual," says Ronny Kraft, CEO of
, which owns shares of Cisco. Silverstein gets "an A for moxie."
Public disagreements between equity analysts and the companies they cover are unusual. Investment banks depend on the lucrative fees generated by underwriting stock offerings and advising mergers for these companies. Equally rare is the publication of such a letter in a forum like First Call, a service best known for compiling analysts' estimates and ratings. Research director Chuck Hill says he cannot recall any precedent.
Silverstein doesn't officially cover Cisco. His colleague Paul Johnson rates Cisco a buy, and Silverstein says the two analysts agree on the matter. Robbie Stephens doesn't have an underwriting or M&A advisory relationship with Cisco. Cisco declined to comment on the letter, saying executives are still reviewing it.
Silverstein says his relationship with Cisco is healthy.
"I think we have enough respect for Cisco that we can" speak frankly on the issue, says Silverstein. "My sentiments were heartfelt on the issue." He adds, "I had a very cordial conversation with Mary Thurber," a Cisco investor relations official, on Thursday.
Like many large tech companies, Cisco considers M&A a primary ingredient in its growth strategy. In April, the San Jose, Calif.-based networking giant
disclosed plans to snap up four companies for stock worth a total of $2.6 billion. Cisco, with a market capitalization of $183 billion, is booking three of the four transactions as poolings.
"There is absolutely no economic difference between the two methods of accounting," Silverstein wrote. Silverstein believes that new bookkeeping standards won't dent Wall Street's high opinion of Cisco.
"These issues are trivial if a company makes a good acquisition," says Kraft with Gotham Capital. Most analysts regard Cisco's track record on acquisitions as strong.
Still, the debate is fresh enough that no consensus has emerged on how to handle purchase accounting. Hill with First Call says he is re-examining how different analysts' earnings models treat Cisco. He worries that analysts are no longer uniformly incorporating the effect of goodwill amortization due to purchases: "Whatever you do, be consistent across the board."
While Silicon Valley is upset about the end of the pooling party, another investment bank agrees with Silverstein that bookkeeping issues don't affect business realities. A recent
Hambrecht & Quist
report predicts that tech companies will escalate their mergers as the deadline approaches and then slow for a while afterward. After that, companies will return to working on growth strategies. "Rational managers will make sure that the 'accounting tail does not wag the strategic dog,'" wrote H&Q Managing Director Paul Cleveland in a public statement.