World's Biggest Inversion Is Boring Investors
For all the fuss over tax inversions and the Obama administration's efforts to prevent them, shares of companies that were able to plow their inversion deals through to the finish line and lock in all those (some would call them nefarious) benefits have to be soaring, right? Not so for Medtronic.
The medical-device maker, valued at $106 billion Monday, is the largest company to have used a merger to decamp to another country where taxes are lower. Pfizer would have eclipsed it, had the $197 billion drugmaker's combination with Allergan not buckled under new rules from the Treasury Department last week. (Medtronic said last week that the new regulations don't have a "material financial impact on any transaction undertaken by the company.") 1
Medtronic traded in its Minneapolis corporate address for an Irish one in January 2015, when it completed a $53 billion mega-merger with Covidien. Since then, its stock hasn't done much of anything -- a puny gain of less than 1 percent, same as the S&P 500, through Monday. (Including its dividend, which Medtronic raised 25 percent last year, the stock returned about 3 percent over that span, also on par with the S&P 500.)
Investors were quite optimistic after the transaction was announced: Medtronic shares surged 24 percent between then and the completion date. But then they turned blase.
Integration can make or break any deal, and what we're seeing with Medtronic is that a strong dollar means it's that much tougher. The company forecasts at least $850 million of annual pre-tax cost savings from the Covidien acquisition by the end of 2018 (its fiscal year ends in April). Last month, CFO Gary Ellis said that while it's actually ahead of schedule on delivering those synergies, currency headwinds are "camouflaging" this. The lower tax rate did help in the third quarter and earnings per share were in line with the consensus estimate, but its operating margin fell short of management's guidance.
One major benefit of the inversion is that roughly $9 billion of cash that Medtronic held in its non-U.S. units became accessible, or "untrapped" as management likes to say. More than half of that money will be paid to shareholders via a higher dividend and share repurchases. Unlike operating synergies, this is certain. The transaction also broadened out Medtronic's offerings, giving it more negotiating power with hospitals.
Medtronic's track record as a dealmaker is spotty, though, and it's also never grappled with a merger this large. As Bloomberg Intelligence analysts Jason McGorman and Ian Person have pointed out, of Medtronic's four other acquisitions that exceeded $1 billion, two of them posted weaker sales growth after the deals were announced. "This may indicate the difficulty of integrating large, complex businesses," they wrote. (To be sure, these purchases were made under a different CEO. Omar Ishrak took the helm in 2011, after running a unit of GE Healthcare.)
On average, analysts see Medtronic's stock rising about 14 percent this year and most recommend buying now. But investors still may need more proof that this merger is working as well as expected.
The Treasury is also targeting a strategy known as "earnings stripping," in which a company that has done an inversion makes a loan to its U.S. subsidiaries. Profits are then moved offshore via the tax-deductible interest payments these units make to the now technically foreign parent company. Medtronic said it will "continue to more fully examine the regulations."
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