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  • Tax-Inversion Takeovers Deliver Market-Beating Returns: Real M&A


    6/30/2014

    Tax-Inversion Takeovers Deliver Market-Beating Returns: Real M&A
    Brooke SutherlandJun 17, 2014 4:42 pm ET

    June 17 (Bloomberg) -- Uncle Sam may not be a fan of cross- border takeovers that allow U.S. acquirers to avoid high corporate tax rates. Investors, however, are cheering.

    Since 2010, stocks of American companies that announced or completed purchases of an overseas target to shift their incorporation abroad and avoid onerous U.S. levies typically outpaced the MSCI World Index, according to data compiled by Bloomberg. They beat the gauge by 15 percentage points, based on the median performance of 14 U.S. acquirers.

    Medtronic Inc., a Minneapolis-based medical-device maker, is the latest and largest company to say it will renounce its American address as part of its planned $42.9 billion takeover of Dublin-based Covidien Plc. While shares of $60 billion Medtronic declined yesterday after the deal was announced, the tax-inversion strategy may free up almost $14 billion in cash the company now holds outside of the U.S., allowing it better use of those funds.

    “They’re just doing what profit-seeking people would do -- arbitrage the tax differences in these geographies,” Todd Lowenstein, a Los Angeles-based fund manager at HighMark Capital Management Inc., which oversees about $16 billion, said in a phone interview. “They’re getting rewarded because it makes sense and the market recognizes that.”

    Inversion deals are on the rise as the largest U.S. companies, facing a corporate tax rate that’s more than double places such as Ireland, seek lower tax rates and ways to spend a stockpile of almost $2 trillion in overseas cash. Medtronic follows some 44 American companies that have reincorporated abroad or plan to do so.

    Injecting Value

    Of 14 companies that announced or completed deals to shift their domicile since 2010, eight have outperformed the MSCI World Index, according to data compiled by Bloomberg. All but three have gained since announcing their transactions.

    “You’re injecting value with the tax benefits,” Martin Sullivan, chief economist at Tax Analysts in Falls Church, Virginia, said in a phone interview. “That gets reflected in the share price.”

    Neither Medtronic Chief Executive Officer Omar Ishrak nor the company’s executive team have to move to Ireland to consummate the purchase of Covidien. While the company’s tax rate isn’t expected to change much, Ishrak said the transaction will let Medtronic better use profit earned overseas, which it plans to reinvest in the industry.

    Big Wallet

    Companies including Valeant Pharmaceuticals International Inc. and Actavis Plc have taken advantage of lower tax bills to pursue additional takeovers.

    “That tax matters,” said Lowenstein. Redomiciling in a lower rate country means “you have a bigger wallet to do things.”

    Valeant has performed the best among tax-inversion companies, gaining 707 percent since it announced plans to buy Biovail Corp. in June 2010.

    Tower Group International Ltd. has had the worst performance, declining 89 percent since it said it would buy Canopius Holdings Bermuda Ltd. in July 2012. While the merger allowed Tower to redomicile in Bermuda, which doesn’t have a corporate income tax, Tower has faced reserve shortfalls. Tower agreed in January to sell itself.

    Shares of Medtronic fell 1.1 percent to $60.03 yesterday after earlier rising as much as 5.3 percent. The size of the transaction and questions on how accretive the deal will be may be giving investors pause, according to Joanne Wuensch of Bank of Montreal. Standard & Poor’s also said it may cut Medtronic’s credit rating because of the deal.

    ‘Bold Transaction’

    Still, the Covidien purchase “makes a lot of sense over time,” Wuensch, a New York-based analyst, said by phone. “It’s a bold transaction. The risks of the integration balance the benefit of positioning this company over time in a changing health-care environment.”

    Medtronic stock climbed 2.6 percent to $61.58 today.

    Corporate inversions that occurred between 1993 and 2013 outperformed the market average in the years following the transactions, according to a report by Elizabeth Chorvat at the University of Chicago. Even so, companies’ stock prices don’t always respond positively to the announcement of an inversion deal, Chorvat wrote.

    Medtronic can walk away from the deal if U.S. tax law changes, the company said in a regulatory filing. The tax clause would also come into play if both houses of Congress pass legislation that would treat the combined company as an American corporation for federal tax purposes, even if it’s not immediately signed by the president.

    Congressional Ire

    The medical device maker is joining the rise in inversion deals as government criticism of the transactions is mounting. After Pfizer Inc. attempted to shift its domicile to the U.K. with an acquisition of AstraZeneca Plc, U.S. Senator Carl Levin, a Michigan Democrat, proposed a bill last month that would make it harder for companies to shift their addresses overseas to avoid taxes.

    In an attempt to discourage more companies from inverting before Congress acts, the bill would be retroactive to May 2014. A congressional panel last month estimated that future deals will cost the U.S. $19.5 billion in tax revenue over the next 10 years.

    More Options

    For now, that’s probably not going to dissuade companies from seeking to re-domicile, said Sullivan of Tax Analysts. In fact, it may spark a surge in deals, he said.

    Exane BNP Paribas analyst Yohann Terry in a report this month identified 33 European companies including London-based medical-device maker Smith & Nephew Plc and Hikma Pharmaceuticals Plc as potential takeover targets for U.S. firms seeking to escape prohibitive corporate taxes.

    “As the profile of these gets raised, there’s always the potential that they may turn off the music,” Tax Analysts’ Sullivan said. “You want to get in before it all ends.”

    *T
    *T
    Performance of acquirers in tax-inversion deals since the
    announcement date:
    
    Acquirer       Target      Date        Return     vs MSCI Index
    
    Medtronic       Covidien   6/16/2014+    -1.1%      -1.1 pct pts
    Chiquita        Fyffes     3/10/2014+    -4.5       -7.2
    Horizon         Vidara     3/19/2014+     1.8       -1.9
    Applied Mater   Tokyo Ele  9/24/2013+    39.8       28.9
    Endo            Paladin    11/5/2013     57.5       49.8
    Perrigo         Elan       7/29/2013      5.6       -8.4
    Actavis         Warner     5/20/2013     67.6       53.5
    Liberty Global  Virgin      2/5/2013     23.2        0.3
    Tower           Canopius   7/30/2012    -89.4     -127.1
    Eaton           Cooper     5/21/2012     78.8       32.3
    Tronox          Exxaro-1   9/26/2011     19.2      -38.5
    Jazz Pharma     Azur       9/19/2011    229.6      180.2
    Alkermes        Elan        5/9/2011    227.0      199.9
    Valeant         Biovail    6/21/2010    706.5      651.7
    
    
    Median                                              14.6
    
    +Pending
    1. Tronox deal was for the mineral sands business of Exxaro.
    
    *T

    --With assistance from Jennifer Surane and Zachary R. Mider in New York.

    UIUC College of Business Department of Accountancy