Is it me, or does it seem like if you blink you'd miss another merger and acquisition deal or rumor in the health care sector?
No rumored deal garnered more notoriety in recent months than Pfizer's proposed takeover over U.K.-based AstraZeneca. Initially starting with a bid that was just shy of $100 billion, Pfizer eventually boosted its bid two additional times to $118 billion only to be rebuffed by AstraZeneca at each turn. Had the deal gone through it would have created the world's largest pharmaceutical company be revenue.
Yet, this wasn't the only M&A activity within the sector by a longshot. Valeant Pharmaceuticals, which is itself aiming to become one of the five largest pharmaceutical companies by revenue within the next couple of years, has launched a hostile $53 billion bid for Allergan after it, too, had every offer rejected by Allergan's management team.
Earlier this week Medtronic (NYSE: MDT ) , the world's largest manufacturer of medical devices, announced a $42.9 billion buyout of Covidien.
In each of these above M&A offers a case was made by the purchasing company that the acquisition would expand its product line and provide ample cost synergies to make a deal handily accretive to long-term EPS.
However, the underlying fact that sticks out about all of these deals is that it would allow a U.S.-based company to move its corporate headquarters address overseas in order to escape a top-end U.S. corporate tax rate of 40%, which is close to double the global average of 23.5% according to KPMG. For companies of the magnitude mentioned above the tax-savings associated with relocating their headquarters overseas will be in the hundreds of millions, if not billions, of dollars. This extra money can lead to rapid business expansion, bigger profits, and potentially even loftier shareholder incentives in the form of beefier dividend payments and share buybacks.
Simply put, with Obamacare lending to uncertainty in the U.S., we could be on the precipice of a great exodus of American companies to overseas countries vis-à-vis buyouts.
With the exception of the United Arab Emirates, every other country around the world offers a lower top marginal corporate tax rate than the U.S. based on KPMG's research. Of course, investors should keep in mind that deductions allow corporations to lower their effective tax rate sometimes well below the top-end marginal tax rate. Countries in Eastern Europe, the Middle East, and even Latin and South America, for example, consistently offer attractively low corporate tax rates for health care companies looking to reduce their tax exposure and boost profits.
Unfortunately, many of these regions don't have health-care companies that U.S. corporations are looking to scoop up. The following three countries, however, might represent the perfect tax haven for health-care companies looking get around the United States' high corporate tax rate.
Perhaps no country stands out as being more friendly to corporations than Ireland whose top marginal corporate tax rate stands at a mere 12.5%, the second-lowest in the European Union. With deductions some business can actually get their tax liability down into the single-digits, which can mean millions upon millions in tax savings. This is why Medtronic investors should be licking their chops as the move to buy Covidien, an Irish-based medical device and supplies company, could mean huge cost saving are on the way.
If I were to highlight a company that I believe could be next on the buy radar that's based in Ireland, I'd choose Jazz Pharmaceuticals (NASDAQ: JAZZ ) . Jazz hits every basic tenet that a purchasing company would be look for:
- Its mid-cap valuation of $9 billion demonstrates its product pipeline is established without its valuation being bloated.
- It's profitable and projected to grow its top-line in excess of 20% per year, meaning a buyout would potentially be instantly accretive to earnings.
- Its lead product used to treat narcolepsy, Xyrem, is well-protected from generic competition and still growing like wildfire.
- And most importantly, it's based in Ireland where corporate tax rates can be about one-quarter what they are in the U.S.
Make no mistake, Jazz has been a rumored buyout candidate before. However, with M&A activity beginning to heat up and health-care companies looking to trim costs in any way possible, Jazz could find itself the object of some larger pharma's affection in the not-so-distant future.
While it's no Ireland, the United Kingdom's top marginal corporate tax rate of 21% is plenty attractive in comparison to the taxes most multinational corporations pay in the U.S. Had Pfizer been able to reel in AstraZeneca it would likely have relocated its headquarters to London, which could have saved the company more than $1 billion annually in taxes.
If you're wondering who could be next, I'd take a closer look at U.K.-based Smith & Nephew (NYSE: SNN ) which had run-up in anticipation that Medtronic would actually make a bid for it instead of Covidien. I'd speculate that Smith & Nephew could be a perfect fit for a U.S. company like Stryker (NYSE: SYK ) since both are primarily involved in the reconstructive implants market.
A combination of Stryker and Smith & Nephew would likely deliver ample cost synergies and, in my opinion, a substantial earnings boost to Stryker's bottom-line over the long-term. Further, with Stryker eliminating jobs directly as a result of the higher costs associated with Obamacare, I doubt it would have any qualms about moving its headquarters overseas to recoup some of its potentially higher health-care costs through lower corporate taxes. Understand that like Jazz above this is merely speculation on my part, but a combination here would appear to make sense.
Lastly, even with its top marginal corporate tax rate jumping from 25% to 26.5% over the past year, I wouldn't discount U.S. health-care companies looking at Israel for a potential corporate tax bargain. Again, while Israel is no Ireland or U.K., it does offer U.S.-based multinationals the opportunity to save millions with a corporate tax rate that, with deductions, is likely close to the global average.
Although this company probably isn't on anyone's buyout radar at the moment, I'd suggest that Israel's Teva Pharmaceutical (NYSE: TEVA ) could make for an interesting addition to any of a handful of big pharmaceutical companies looking to hedge against their pending patent cliff losses. Teva itself is set to lose patent exclusivity on Copaxone, its blockbuster multiple sclerosis drug that accounts for about a fifth of its revenue, but investors often forget that it derives close to half of its revenue from its vast generic products portfolio.
In the first quarter Teva generated $2.4 billion in revenue from generics, up 3% from the year-ago period, out of $5 billion in total quarterly revenue. With insurers and physicians pushing generics based on their lower cost I'd expect their importance to only increase as the years go by, meaning Teva's average annual free cash flow generation of more than $2 billion is probably safe. Big pharmaceutical companies looking to hedge their growth against patent losses (ahem, Eli Lilly) while also saving money with vis-à-vis lower corporate taxes might be wise to consider giving Teva a closer look.
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