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Motif Spotlight: Tax Inversion Invasion

22 August 2014 in Trading Ideas

A new tax-reduction strategy gaining popularity among US mega-corporations looks like it will continue as part of the toolkit – despite possible efforts to derail its use.

The method is called “inversion” – it lets American corporations move their tax residency abroad by being “bought” by smaller foreign firms in order to reduce their US corporate income tax bills.

The two-biggest inversion deals this year have involved relatively low-profile US healthcare companies. In June, Medtronic agreed to be bought by Dublin-based Covidien for $42.9 billion, and a month later Abbvie inked a merger deal with UK-based Shire.1

Just recently, fearing a growing public backlash against such deals, US-based Walgreen said it would not pursue a takeover of Alliance Boots in a move that would have allowed the company to move its tax domicile to Switzerland or Britain.


Still, the tax inversion maneuver appears here to stay – at least for now. And its growing use led to our latest investment idea: the Tax Inversion Targets motif, a portfolio of stocks of foreign-based companies that could be viewed as merger candidates for US-based companies looking for a new tax home.

The motif’s segments are broken out by geography. A few of the portfolio’s top holdings currently include Silicon Motion Tech (6.2% motif weighting), GW Pharmaceuticals (5.1%), Vistaprint (4.6%) and Logitech (4.1%).

With more than 50 companies having reincorporated themselves in the past 10 years,2 bringing their tax rates down to 12.5% from the 35% in the US, the possible benefit to the bottom line can practically speak for itself.3 But acquisitive companies can also create shareholder value by reducing their tax liability and funneling cash flows to investors in the form of dividends and stock buybacks.

Here’s another possible upside: Research has shown that companies involved in inversion deals have outperformed the market by almost 13% in the first year of the merger.4

It’s worth noting that tax inversion deals aren’t popular with everyone. As the Financial Times recently pointed out, political attacks have been building for weeks. President Obama and some Democrats are looking to make the issue one of the themes of the upcoming midterm elections and have branded tax-inversion acquirers as “corporate deserters.”

However, analysts at Bernstein recently suggested that such remarks don’t amount to much more than political “saber-rattling.”4

They contend that inversion deals – especially in the healthcare sector – will continue because a) many of the deals are driven by the desire to gain scale and cut operating costs, neither of which are dependent on tax inversion deals; and b) any punishments pursued by US Treasury against companies like Medtronic are unlikely to offset the deal’s benefits. Medtronic, for example, doesn’t rely on government contracts, and medical device companies have tended to have strong cash flow and low debt.

We should also point out that the search for candidates of inversion deals is not exact science and not without risk. These companies trade on US exchanges and are located in countries that currently have favorable tax rates and are generally in sectors have previously been receptive to this strategy.

Still, if you’ve been increasingly intrigued by possible investment opportunities arising from the uptick in tax inversion mergers, this motif could be worth your consideration.

1Barney Jopson, “US groups ponder the great tax escape,” ft.com, Aug. 8, 2014.

2David Zeiler, “Tax Inversion Deals: Washington Blames Wall Street for Its Mess”, moneymorning.com, July 28, 2014, “http://moneymorning.com/2014/07/28/tax-inversion-deals-washington-blames-wall-street-for-its-mess/,” (accessed Aug. 11, 2014).

3KPMG data, – http://www.kpmg.com/global/en/services/tax/tax-tools-and-resources/pages/corporate-tax-rates-table.aspx, (accessed Aug. 11, 2014).

4Denise Roland, “Tax inversion crackdown ‘unlikely to derail deals,” telegraph.co.uk, Aug. 11, 2014, http://www.telegraph.co.uk/finance/newsbysector/pharmaceuticalsandchemicals/11025742/Tax-inversion-crackdown-unlikely-to-derail-deals.html, (accessed Aug. 19, 2014).