) recent $5.3 billion all stock deal with
) has once again emphasized an increasingly important driver of
M&A activity this year. Several factors have contributed to the
seven-year high in M&A deal value. But recurrent foreign
acquisitions by U.S. companies indicate that tax inversion is one
of the major reasons.
Increase in M&A Activity
The lack of organic means of growth for many U.S. companies meant
that mergers and acquisitions were the next best route to get
bigger. The presence of large amounts of cash on corporate balance
sheets, favorable credit markets, low interest rates and strength
in the stock market provided a conducive environment for M&A
activity to gather speed.
Some of the most notable deals include
) $19.0 billion buyout of WhatsApp and
) acquisition of Forest Laboratories for $25.0 billion. Further,
), the world's largest medical devices maker, acquired its Irish
rival Covidien Public Limited Company for $42.9 billion.
What Is Tax-Inversion?
Medtronic's $42.9B acquisition of its Irish competitor in surgical
technologies and global healthcare major Covidien plc is a good
example of the tax inversion process. The deal was an effort to
offset the impact of high U.S. corporate tax rate by shifting
Medtronic's tax base overseas.
At 35%, the U.S. corporate tax rate is one of the highest rates in
the world. A tax inversion involves the acquisition of a foreign
company and subsequently adopting its home country's domicile.
Alternatively, the combined entity can create a holding company in
a country whose tax rate is lower.
This could help U.S. companies reduce their tax rates to single
digits. The conditions attached to such a move specify that 20% of
the stock of the resultant entity must be transferred to the
shareholders of the company which has been acquired.
Popularity in the Healthcare Sector
The inversion wave has affected the healthcare sector the most.
Medical devices and pharma companies are rapidly acquiring smaller
foreign competitors for two major reasons. Firstly, the industry
has been a natural leader in the M&A space. This is because it
is usually easier for a large corporation to purchase small
companies than to develop new drugs indigenously. Secondly, the
market for drugs is truly international.
Additionally, several large pharma companies already have
considerably large international profits. Tax inversion removes the
necessity of repatriating such profits, making them subject to a
higher tax rate. A strong European pharma sector also makes for
several potential targets.
Major Deals This Week
Ultimately, as several healthcare companies conclude inversion
deals, others are pressured to follow suit. This week alone markets
received news of two such massive deals. Mylan will acquire Abbott
Labs' branded specialty and generics business in developed ex-U.S.
markets for $5.3 billion. The new company, organized in the
Netherlands, will be headed by Mylan's present leadership group.
Mylan stated in its press release that in the first full year
following closure, its tax rate will be in the range of 20% to 21%
and decline further (high teens) going forward. The formation of
the combined entity is expected to result in more than $200 million
in pre-tax operational efficiencies by the end of the third year.
Meanwhile, a fifth offer of $53 billion from Chicago-based
) has received tentative approval from Irish drug company
). This would be the biggest deal of the year upon completion.
Senate Roadblocks Ahead?
Earlier this week, Treasury Secretary Jack Lew said Congress should
pass legislation to end tax inversions. In his letter to
Congressional leaders Lew said: "We should not be providing
support for corporations that seek to shift their profits overseas
to avoid paying their fair share of taxes."
However, the legislation, similar to a provision in the latest
federal budget proposal, is unlikely to find favor with Congress as
a whole. There is broad agreement in principle among a large
section of Congress about the need to amend the tax code. This
would entail lowering the corporate tax rate of 35% and firming up
international tax rules. However, Republicans and Democrats have
not been able to agree on the details as well as on changes in
Given the current regulatory environment, it is unlikely that deals
involving tax inversion will face regulatory roadblocks in the
short term. The benefits to the companies involved are more than
apparent. This is particularly true for the healthcare sector.
Clearly, more M&A activity involving tax-inversion can be
expected in the days ahead.
Want the latest recommendations from Zacks Investment Research?
Today, you can download 7 Best Stocks for the Next 30 Days.
Click to get this free report
MYLAN INC (MYL): Free Stock Analysis Report
FACEBOOK INC-A (FB): Free Stock Analysis Report
SHIRE PLC-ADR (SHPG): Free Stock Analysis
ABBVIE INC (ABBV): Free Stock Analysis Report
ACTAVIS PLC (ACT): Free Stock Analysis Report
MEDTRONIC (MDT): Free Stock Analysis Report
ABBOTT LABS (ABT): Free Stock Analysis Report
To read this article on Zacks.com click here.