Seeking Alpha
Long/short equity, special situations, value
Profile| Send Message|
( followers)  

Summary

  • Walgreen's potential to make a tax inversion move is creating bad publicity, weighing on shares.
  • A potential move to Switzerland could save shareholder billions in dollars at the expense of the budget and taxpayers.
  • Backlash is increasing as politicians wake up. In either case, the long-term looks healthy following the huge Boots deal.
  • Yet I would only buy on significant dips after strong momentum this and last year.

Walgreen (NYSE:WAG) saw weakness on Thursday as shares fell 3% as backlash regarding a potential tax inversion move is on the increase.

This comes after the European Commission started an investigation regarding tax rules and specific tax strategies employed by US prominent multinationals. In the US, politicians have been heating up the debate about ¨inversion¨ and repatriation charges.

Walgreen Looking To ¨Move¨ To Europe

News reports have surfaced recently indicating that the largest US drugstore retail chain is looking to move its ¨headquarters¨ to Europe after an attractive package of Illinois tax credits is expiring. In the report, it is being mentioned that Walgreen was contemplating to move to Switzerland.

The American For Tax Fairness advocate group estimates that the ¨inversion¨ move could cost the US people some $4 billion in missed tax revenues in the time span of just five years. This calculation is based upon statutory tax rates of 35% in the US which are just 20% in Switzerland.

The move is even more controversial as Walgreen is benefiting from increased Medicare and Medicaid drugs benefits after the introduction of the Affordable Care Act, paid for by society at large.

Acquisitions Are Driven By The Tax Code

The discrepancy between the tax codes in the US and specific European countries have resulted in US companies becoming creative in their way of conducting business. Companies like Starbucks (NASDAQ:SBUX) and Apple (NASDAQ:AAPL) have used license fees and transfer pricing arrangements to minimize their tax bill by setting up European ¨superficial¨ entities.

Other prominent names like General Electric (NYSE:GE) and Pfizer (NYSE:PFE) have or are in the process of acquiring European companies being paid for by cash held abroad, avoiding cash repatriation charges. ¨Good¨ tax citizens has been eBay (NASDAQ:EBAY) for example, which took a multi-billion repatriation charge after bringing back foreign cash. This is as debate about the issue is heating up with many companies pleading for a tax holiday.

Notably Apple and GE have been under pressure from watchdogs and consumer advocacy groups for a long time for their very low effective tax rates at a time when consumers and the Treasury budget have been suffering.

Why Switzerland?

The potential move to reincorporate to Switzerland is based on Walgreen's 2012 purchase of 45% of pharmacy retail chain Boots. Following the acquisition of the remainder of the shares in this company, which is anticipate to occur next year, Walgreen might make an ¨inversion¨ move as soon as 2015.

After acquiring the remainder of the shares, it would not be unthinkable to see Walgreen making a move to the Switzerland. Citations from executives of the company leave room for such a potential move. Vice President Rick Hans says "we've ever been a proponent of paying more taxes than we have to."

Implications For Investors

Inversion moves, complicated offshore accounts and questions about repatriation charges have become more common in today's political debate. Companies which made such moves earlier and don't directly deal with consumers have had the potential to save a lot of cash, while facing relatively little bad publicity.

Yet an acceleration in the number of companies contemplating these moves, and many large scale businesses considering making such moves, have increased the backlash.

For the year of 2013, Walgreen reported earnings before income taxes of $3.89 billion. A tax bill of $1.44 billion resulted in a rather steep 37.0% effective tax rate. Applying a 20% tax rate would put the bill at $778 million, boosting net earnings from $2.45 billion to $3.11 billion.

The additional $660 million in annual earnings are worth a lot with shares trading at steep multiples today, potentially creating billions in shareholder value which easily explains why investors are happy to take on some bad publicity.

Takeaway For Investors

I guess that investors should applaud the move which could really save big bucks for shareholders, but it seems that political backlash against these deals is increasing rapidly as these kind of moves are very damaging to national budgets and consumers.

The continued momentum in healthcare, pharmacies and solid comparable store sales have pushed up Walgreen's shares by 26% already this year. At $72 per share, equity is already valued at $69 billion, the equivalent of 0.9 times trailing revenues of $74.2 billion and 25 times trailing net earnings of $2.7 billion.

Note that these are steep multiples based on past performance. Following the complete acquisition of Boots, Walgreen is targeting revenues of $130 billion by 2016 which should drive operating earnings to levels as high as $9 billion. At such earnings levels, the impact of lower taxes is even greater.

With a net debt position of roughly $10 billion after factoring in the full acquisition of Boots, net earnings could improve to roughly $7 billion after accounting for interest rates and lower Swiss tax rates.

Based on those metrics, the valuation looks much more appealing based on 10 times earnings two year's ahead in time. If the company remains in the US net earnings would come in much closer to $5.5 billion, which diminishes the appeal for the significant margin.

As such you can see the importance of a tax move and you can understand why shares sold off some 3% on Thursday with controversy regarding the issue heating up. I personally don't believe that an inversion will be very likely given the increased backlog. Worse, I actually believe that a significant part of this year's momentum has been driven by such an inversion move.

In either case, the Boots case might drive earnings going forward although this might not be the best time to buy. I am a buyer on larger and more pronounced dips as I like the growth story based on the deal with Boots, irrelevant of the tax story.

Source: Walgreen: Potential Tax Inversion Move Creates Public Backlash