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Merger Landscape Still Inviting to Inversions

2 December 2015 in Trading Ideas

A deal that’s on track to be the year’s biggest corporate tie-up has made a splash beyond its $140 billion price tag.

Earlier this month, Pfizer Inc. (NYSE:PFE) and Allergan PLC (NYSE:AGN) announced they’re looking to merge in a deal that actually calls for the smaller Dublin, Ireland-based Allergan to purchase US-based Pfizer – with the combined entity then residing in Ireland, which offers a jurisdiction of lower offshore taxes.1

As the Wall Street Journal explained, whichever way the deal is technically structured, the much larger Pfizer will effectively be buying Allergan and assuming the lower tax domicile. Allergan shareholders would receive a premium and end up with 40% to 45% of the combined company.

Somewhat ironically, news of the merger came just as US Treasury officials stepped up their attempt to limit and/or outlaw these “inversion” deals in the wake of their growing popularity.

Indeed, in the past few years companies have been rushing to sign up acquisitions of foreign targets ahead of US government attempts to crack down on the deals. In September 2014, the Treasury Department tightened inversion rules after high-profile US companies such as pharmaceutical giant AbbVie Inc (NYSE:ABBV) struck deals that would take them overseas.

AbbVie later backed away from its deal amid the pressure rising against such transactions, according to the Journal.

The changes issued last month by the US Treasury build on existing tax laws that prevent companies from escaping the US tax system unless they merge with a foreign firm. Current law allows inversions to proceed as long as the US company’s shareholders own less than 80% of the combined company.2

The latest rules go after a technique known as “stuffing,” in which the non-US company is artificially made bigger before a merger to comply with that 80% threshold, the Journal reported.

They also make it harder for companies to do what the Treasury calls “cherry-picking,” which is finding an address in a country with a favorable tax treaty. They will instead be more limited to taking new addresses in the country where the merger partner is organized.
However, despite increasing scrutiny and action by the Feds, inversion transactions have shown little slowdown in popularity.3

In the year since the Treasury Department tightened its rules, six US companies have completed inversion deals, compared with the nine that did so the year before.

Meanwhile, foreign takeovers of US companies have soared, with similarly draining effects on US tax coffers.

These deals heighten the challenge for Washington to hold onto corporate tax dollars amid a global merger boom. US businesses, which are subject to a 35% tax rate, are worth more in the hands of more lightly taxed foreign rivals. The savings let overseas buyers offer high prices for those assets, which ramps up pressure on American boards to sell.

Meanwhile, the pressures that drive inversions remain, and they make US companies attractive takeover targets for foreigners, according to the Journal. Overseas buyers of American companies can reap the same tax savings that inversions produce.

The value of foreign takeovers of US companies has risen to $379 billion so far this year from $71 billion over the same period in 2013, according to data from FactSet cited by the Journal, outpacing the rise in global M&A volume.

Since the start of 2014, foreign companies have spent twice as much buying American rivals than the reverse, despite a strong US dollar and economic weakness that has driven down asset prices in some parts of Europe.

Regulators are “telling U.S. companies ‘we’re going to make it hard to leave,’ but telling European companies ‘it’s fine to come and buy,’” Larry Bambino, a tax partner at law firm Shearman & Sterling LLP, told the Journal.

Now, several members of Congress are trying to line up support for a tax overhaul that they say could reduce the incentives for companies to move overseas. But the Journal said that many doubt a bill can get passed before the 2016 election cycle hits full speed, and few agree on what an overhaul should look like.

That could mean that inversion mergers carry on for now, with significant upsides for the stocks of companies targeted for their low-tax locations.

The Tax Inversion Targets motif has gained 6.1% in the past month. In that same period, the S&P 500 has increased 0.1%.
In the last 12 months, the motif has risen 6.4%; the S&P 500 is up 0.6%.

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1 Jonathan D. Rockoff, Dana Cimilluca and Dana Mattioli, “Allergan-Pfizer Talks Include Allergan as Possible Buyer,” wsj.com, Nov. 19, 2015.
2 Richard Rubin, Jonathan D. Rockoff and Dana Cimilluca, “Pfizer Heads for Fight With US on Tax-Saving Allergan Deal,” wsj.com, Nov. 19, 2015.
3 Liz Hoffman and John D. McKinnon, “Curbs Don’t Stop Tax-Driven Mergers,” wsj.com, Sept. 21, 2015.