Inversion Deals Are Costing The U.S.

by: Enlight Research, LLC

Originally published on July 18, 2014.

By Tyler Sparks

The life sciences industry, particularly pharmaceuticals, is ripe with competition. Companies are constantly looking for ways to increase margins and reduce expenditures. One way that companies are now looking to accomplish this task is by structuring inversion deals through mergers and acquisitions. The U.S. stands to lose close to $20B in revenue from companies moving overseas.

Inversion Deals

An inversion deal is formulated by companies to bypass tax implications. An example can be found in recent mergers and acquisitions activity between US companies and overseas companies. Abbvie Inc. (NYSE:ABBV) is in talks with Shire Plc (NASDAQ:SHPG) on a potential takeover purchase. Bloomberg reports that one of the main components of the purchase is an inversion deal, to cut AbbVie's tax rate to 13 percent from the current 22 percent just by moving its legal address from the U.S. to the U.K. made possible by acquiring Shire.

The Wall Street Journal notes that some companies are now willing to pay a higher premium because the long term savings of a tax cut gives value, sometimes offering 50% more than the acquired companies are worth. This practice may eventually lead to inflated and overvalued price targets on companies that operate abroad, as well as potentially stricter regulations in multinational merger and acquisition activity. US policy makers are now threatening to change the laws that provide businesses with huge advantages.

Recent Deals

In the past few years, numerous deals have been made to re-incorporate companies abroad. Although there have been rumors of policy changes, companies are still going forward with deals but are careful to mitigate their risk.

A recent merger between Salix Pharmaceuticals Ltd. (NASDAQ:SLXP) and Cosmo Pharmaceuticals SpA involves three patents for gastrointestinal drugs. Salix purchased these patents in the form of stock for a total of around $2.7B. This purchase ultimately allowed Salix to move to Ireland and lower its tax bill. A merger like this is beneficial to both companies. Salix gets substantial tax cuts while Cosmo gets to "leapfrog into the U.S. market without any incremental costs," as quoted by Friedrich von Bohlen, managing director of Dievini Hopp Biotech Holding GmbH, Cosmo's second-largest shareholder.

This past June the medical device maker Medtronic Inc. (NYSE:MDT) signed an agreement to purchase Irish based Covidien PLC (COV) for $42.9B. Medtronic has the intention of becoming an Irish company for tax cuts. However, Medtronic is protected by a clause "allowing it to walk away if the tax regime changes to remove those benefits." This shows how important the tax benefits are to companies. Medtronic is willing to completely change its M&A activity based solely on international tax policy.

Another deal agreed upon in June was the merger of Canadian QLT Inc. (NASDAQ:QLTI) with Pennsylvania based Auxillium Pharmaceuticals (NASDAQ:AUXL) allowing the company to take the lower Canadian tax rate. As explained earlier, the companies were concerned with the risk around the inversion and it became a point of contention between them. Similarly to Medtronic, Auxillium installed a clause lasting till October 31st allowing them to walk away from negotiations without facing any penalty if the laws are changed. If accepted, the deal should close by the year-end.

Installing contract provisions is popular among companies to mitigate risk and please shareholders. When California based Applied Materials Inc. (NASDAQ:AMAT) negotiated the purchase of Tokyo Electron Ltd. for $9.39B they made sure to include a provision keeping them safe from paying a $400M breakup fee if the tax benefits were somehow blocked. Executives spoke about how the companies would create a more "expansive knowledge base" by bringing together technologies and product. Although it mentioned the Netherlands would house the new company, it did not mention that its tax rate would be lowered to 17% from 22%.

Moving Forward

For companies that operate in different areas of the global market, a cheaper tax rate is appealing. For example, the US tax rate on corporations is 35%, compared to an Ireland corporate tax rate of 12.5%. Ireland is just one example, but there are numerous countries that have a better tax rate to offer companies. As mentioned, companies are looking to mergers and acquisitions to take advantaged of these tax rates. With this changing landscape long term implications are hard to foresee, but tax cuts could lead to more regulations, not just in tax law, but in all regulated aspects of the life sciences business.

People are now calling for "economic patriotism," pushing the idea that companies should receive tax breaks to make staying in the United States competitive against other companies. Jacob Lew, U.S. Secretary of the Treasury, said this week, "Congress should enact legislation immediately." He argues that if the US doesn't cut tax rates soon, then the nation's global companies will just continue to move their headquarters-- saving the company millions in taxes. Consequently, it will cost the US government millions in tax revenue, money that the country desperately needs to keep our economy flowing. With more attention being put on tax legislation, it will be interesting to see how, and how soon, our national lawmakers react.

Disclosure: None.