Deals

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

The U.S. Treasury Department has thrown down the gauntlet in its campaign against corporate inversions.

For years, calls have been mounting for the agency to enact roadblocks to keep U.S. corporations from using acquisitions to move their legal addresses abroad for tax benefits. Previous attempts at a crackdown weren't tough enough to stop companies' steady march out of the country, and the thinking was that Treasury officials didn't have the power to go much further on their own. 

Well, they apparently decided enough is enough. The new regulations put forth late Monday are the toughest yet, and much more aggressive than anticipated. And while the legal authority of the Treasury here is somewhat murky -- it's not clear whether the proposed regulations are enforceable without official backing from Congress -- merely going this far may produce a chilling effect on future and pending inversions. These include drug giant Pfizer's $160 billion merger with Dublin-based drugmaker Allergan, the biggest inversion to date. 

Deal Doubts
Shares of would-be inversion targets fell on the news of the Treasury Rules.
Source: Bloomberg
Intraday times are displayed in ET.

The proposed regulations go after inversions in two ways: First, they would exempt American assets acquired by a non-U.S. company or a recent inverter within the last three years from counting toward that foreign entity's size. This would make it harder for U.S. companies seeking an inversion to find partners big enough to make one work.  Second, they would place restrictions on "earnings stripping" -- a tactic used by inverted companies to effectively shift profit to lower-tax countries by having the U.S. company pay interest to its new foreign parent on inter-company loans. The Treasury is seeking to reclassify at least some of that debt as equity, making the distributions taxable and removing the biggest benefit of an inversion.  

Here are some takeaways about the new rules and their potential impact:

Changing the Equation
The proposals, particularly the attack on so-called "serial inverters," seem drawn up specifically to thwart the Pfizer-Allergan deal. Allergan, formerly based in California, took on a foreign address only last year when it was acquired by Actavis, a company that itself was built through an inversion and a series of subsequent U.S. takeovers. The inversion math for Pfizer-Allergan just doesn't work anymore if the assets from all these prior deals aren't able to be included in the equation. Pfizer is examining options including fighting the rules in court or restructuring the deal, people familiar with the matter told Bloomberg News.  Reuters reported it's leaning more toward killing the transaction. 

Targets No More?
Inversions weren't going to stop until the government made them completely unappealing; it looks like the Treasury has now succeeded or at least sent a strong enough message to make corporations think twice.  

That means companies often speculated as takeover targets because of their foreign addresses -- including inverted firms such as drugmakers Perrigo, Mylan and Endo -- are now less attractive. That's not to say a takeover couldn't still happen for strategic reasons, but the tax benefit that made those companies stand out amid the field of acquisition opportunities has been significantly diminished. They're certainly not going to command the type of premium that they otherwise might have. 

Losing Luster
Once thought of as likely takeover targets, Endo, Perrigo and Mylan don't have as much to offer buyers under the new Treasury rules. All three dropped Tuesday, led by Endo.
Source: Bloomberg
Intraday times are displayed in ET.

Dublin-based Shire, which has been speculated as a takeover target since an inversion with AbbVie blew up amid a previous round of Treasury rules, could also be a less appealing acquisition candidate. That's because under the new Treasury rules, the pending acquisition of Baxalta likely wouldn't be counted toward its size in a potential inversion.  The Treasury proposals also might give cranemaker Terex more reason to pick the higher offer from Chinese interloper Zoomlion over its agreed-upon inversion deal with Finnish competitor Konecranes.

Dented Benefit
The proposed earnings-stripping restrictions apply to all inter-company loans of a certain size issued after Monday. That means companies such as Medtronic that perhaps thought they were in the clear after their inversion transactions closed risk losing some of the benefits of those deals. It's not likely that any past inversions will be undone and the earnings stripping rules aren't meant to be retroactive, but they may affect the tax calculus for companies going forward.

The earnings-stripping tactic is also used by multi-national organizations with significant U.S. operations, so these proposals could have a much broader effect. There's already been some pushback, with the Organization for International Investment saying the Treasury's action would increase the cost of investing in the U.S. for all foreign companies and put more than 12 million American workers at risk. 

Still Possible
The Pfizer-Allergan deal isn't the only pending inversion at stake. Other transactions include CF Industries' acquisition of fertilizer assets from Dutch company OCI NV; trash collector Waste Connections' plan to combine with Canada-based Progressive Waste; air-conditioning systems maker Johnson Controls' proposed merger with Ireland-based Tyco International; and IHS's combination with U.K.-based financial-data provider Markit. All of those deals could conceivably still happen -- at least structurally speaking -- because the foreign partners haven't made significant American acquisitions in the past three years. The terms might need to be adjusted, but the companies have a legal path to proceed with their plans.

trash-inversion-new-Brooke

The question is whether these deals are as appealing now that earnings-stripping is under fire. There are still advantages to being a Canadian or Irish company, but the ability to shift U.S. income to these lower-tax jurisdictions was certainly a primary motivator for inversions. IHS and Markit said that the new rules won't affect their plans or their tax guidance, signaling they weren't really banking on the benefits. BMO says the rules shouldn't blow up CF Industries' planned inversion because the company had already modeled for a scenario where earnings-stripping wasn't permitted.

Waste Connections and Progressive Waste said they remain committed to the deal and that the impact of the new rules should be minimal, based on a preliminary reading. Johnson Controls said it's still reviewing the Treasury's proposals. The point is inversions are still possible with the right conditions.

--Rani Molla contributed graphics to this article.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. The U.S. company must own less than 80 percent of the resulting entity to move its address abroad via an inversion. If the U.S. company ends up with between 50 percent and 60 percent of the combined entity, the deal is not technically considered an inversion and thus, not subject to the prior Treasury rules that made it harder for companies to do things like access overseas cash tax-free. 

  2. Among these foreign counterparts, Tyco is the product of an inversion, having gained a Bermuda address in the 1990s. It's now based in Ireland after a stint as a Swiss company. 

To contact the author of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net