Cooper Company (CC), a public company based in Western Canada, recently acquired the leasehold interests in 220 sites and the website of Messer Corporation (MC), a company operating a chain of bookstores and an online bookstore in Eastern Canada. As part of CC’s expansion strategy into Eastern Canada CC must maintain its net income figure and equity level in order to comply with the debt-to-equity covenant imposed by the lenders who are helping CC to finance this acquisition.
MC, which was founded by George Messer in 1945 to encourage Canadians to read, has struggled to compete in recent years due to the low prices offered by a North American online giant and CC’s online store. The Messer family has concluded that it would be in its best interest to sell these leasehold interests and its website to CC.
CC has agreed to pay MC $150 million in two equal payments of $75 million, in addition to the acquisition-related costs of $250,000, to acquire the leasehold interests in 220 of the sites currently operated by MC and its website. These payments are expected to be made in May and September of 2014. The fair market value of the leasehold interests were $80 million and the website was $15 million. The average remaining life of the leases is 10 years. MC will sublease these sites from CC and continue to operate them under the MC brand for a period of time. The stores will then be wound up and started to be operated as CC stores in the locations. The existing installations will be removed by CC as part of a renovation project for all of the stores so that they are consistent with existing CC stores. CC expects to open 100 to 150 CC stores throughout Eastern Canada in 2014 and 2015, with the remainder there-after. The financial returns on these stores are expected to be in line with returns on new CC stores. These stores will provide a strong, initial foundation for an increased CC presence in Eastern Canada over the next five years.
MC had 279 stores, of which 220 are being sold to CC. MC plans to wind up the remainder of the stores.
CC plans to transition the incorporation of MC’s website within its own website. For a period of time, the MC website will still exist in online search engines. However, once at the MC website, users will be directed to CC’s website automatically. This is for consumers who are not aware of the sale to CC.
It is presently January 2014, and the CFO of CC thought that they would be able to account for this transaction as a business combination and recognize part of the amount paid as goodwill and also to capitalize the acquisition costs.
However, he was told by the assistant controller that this would not be considered a business combination. The CFO and assistant controller have come to you, a consultant, for your advice concerning this transaction.
Required
Prepare a report to the CFO and assistant controller providing recommendations regarding the transaction.