If lowering tax rates was not the objective of this year’s wave of corporate inversions, as many executives claim, then today’s share price declines for European targets would be irrational. After all, why would the Treasury Department's tightening of rules against US corporations domiciling in lower-tax jurisdictions affect overseas strategic acquisitions that are not driven by tax inversion?
Investors know better. The potential of AbbVie to have new limits placed on its ability to utilise offshore cash, for example, will probably change the calculus of its deal to buy Shire. Change is clearly coming in how the US taxes corporations, and the Treasury’s new inversion rules signal that the debate is entering a new phase.
President Barack Obama’s administration took advantage of the pre-election congressional recess to announce the measures, which effective yesterday will tighten rules implemented under existing laws to stop or slow pending or future inversions. Congress will not be able to intervene in the Treasury's action, if it decides to do so, until after election day on November 4, and probably not until after the new legislature organises in 2015.
The issue could be useful for Mr Obama’s Democratic allies running for office in this mid-term contest, and he has given them some ammunition for the fight; Democrat-backed legislation goes further than what the Treasury has proposed, but has little chance of passing (Anti-inversion noise grows but power to act is limited, August 11, 2014).
Treasury Secretary Jacob Lew’s announcement had its most immediate effect across the ocean, however, where companies that have been targets or are thought to be targets saw steep share price declines in trading today.
Shire was off 3% in afternoon London trading and now stands at £51.30, nearly £5 below the AbbVie offer valuation; the Irish-domiciled, US-listed Covidien, the subject of a takeover by Medtronic, slid 2%; AstraZeneca, a former and possibly future Pfizer target, was off 5%; and UK-based Smith & Nephew, subject to numerous M&A rumours, was down 4%.
On the continent, a much-discussed potential prize, Actelion, was down 2%, and Cosmo Pharmaceuticals fell 8%, although this latter move was perhaps due to Allergan's machinations threatening its takeout by Salix Pharmaceuticals (Salix and Actelion reveal an anti-chain in overdrive, September 23, 2014).
As EP Vantage noted in July, Washington’s chatter on inversions meant that there were low but still significant risks to AbbVie’s M&A moves, which could see invocation of the Illinois-based group’s obligation to pay billions in break fees if the tax saving maths no longer works (AbbVie brushes off US talk and sweeps up Shire, July 18, 2014). Investors now see this risk as rising.
Nuts and bolts
Because of the Treasury’s limited power to change a congressionally enacted law, Mr Lew’s proposals are fairly modest. For example, there is no requirement for Mr Obama's previous call for shareholders of the former US company to own no more than 50%, rather than 80%, of the new company for the tax re-domiciling to be authorised.
What the new measures do is restrict the financial transactions that allow companies to meet this ownership threshold, such as reducing the US company’s size pre-merger through special dividends, or using passive assets of the foreign company, such as cash, to inflate its value. Other measures restrict the use of a common tax dodge, repatriating cash by designating dividends from a foreign subsidiary as so-called “hopscotch loans”.
In a note this morning, Bernstein Research analyst Ronny Gal wrote that the AbbVie-Shire deal was probably not burdened by any of the limitations around the ownership balance. However, he said that because more than half of Humira sales lay outside the US, any increase in taxes on repatriated income would make the Shire buyout less attractive. AbbVie justified the high price it paid for Shire in part by estimating that it could cut its tax rate from 22.6% in 2013 to 13% in 2016 – attempts to renegotiate the terms in order to achieve favourable rates following the Treasury's action could cause the deal to unravel and fall apart.
Deal bankers and companies on the hunt for targets are no doubt reading the Treasury announcement and reopening their spreadsheets today. The US government has not stopped corporate emigration in its tracks, but on the margins some deals will no longer make sense.
To contact the writer of this story email Jonathan Gardner in London at firstname.lastname@example.org or follow @JonEPVantage on Twitter