The past few years have seen more corporate mergers that led to inversions than the 20 years prior combined. While opinions differ as to whether it's unpatriotic for U.S. companies to relocate abroad in order to reduce their tax bills, the reality is that more and more companies will explore it as a way to improve their business prospects. So is there a way for investors to profit from this trend?
It's not exactly easy for retail investors to participate in the upside of corporate inversions. However, Motif Investing has put together something that could open the door for those interested in this trend. I spoke with Motif CEO Hardeep Walia about what the company is offering.
Explaining inversions and clearing up misconceptions
Every company pays corporate taxes on business that it does in a specific country, so when a company moves its corporate headquarters, it's not exactly dodging taxes. For example, Burger King Worldwide (UNKNOWN:BKW.DL) will continue to pay taxes on its profits in the U.S. after it relocates to Canada, once the merger with Tim Hortons (UNKNOWN:THI.DL) is complete. But it will reduce its tax bill when it repatriates earnings from abroad to its home country.
Today, Burger King must pay U.S. tax rates on any cash that it brings back from foreign business. It gets a credit for taxes paid in the country where the cash was generated, but it still has to pay the difference to the federal government here. For companies bringing international profits to the U.S. to pay dividends, reduce debt, or expand domestic operations, it almost feels like a punishment to impose a higher tax rate on profits that weren't generated by U.S. sales -- at least, according to those who support tax inversions.
This might be an oversimplification for companies whose international sales are largely driven by American operations, and our convoluted tax code has many loopholes and credits that can significantly reduce a company's "effective" tax rate, but that's a topic for another article.
What about making money on inversions?
There are two ways to profit from inversions. The first is by owning shares of companies that become more profitable by relocating to another country. The second method is to invest in companies that have a high likelihood of being acquired by another company pursuing inversion. The thing is, it's not easy to identify a sufficient number of potential targets and then invest in them.
Enter Motif Investing, an online brokerage that has taken a different approach. The company offers hundreds of different "motifs" -- custom-built collections of up to 30 different stocks, similar to ETFs. The buyer pays only one trading fee, usually about $10. You can even make your own Motif.
Motif's "Tax Inversion Targets" offering includes 25 companies that are located in tax havens, operate in industries that have seen a lot of tax inversion activity, and have strong businesses prospects beyond being potential acquisition targets. Companies in the motif include Ireland-based Jazz Pharmaceuticals (NASDAQ:JAZZ), U.K.-based microprocessor designer ARM Holdings (NASDAQ:ARMH), and Cayman Islands-based Fresh Del Monte Produce (NYSE:FDP).
Walia had the following to say when we spoke:
The advantage of buying the acquiree is you benefit from not just the tax inversion, but also the premium from being acquired. We focus on U.S.-listed securities headquartered abroad, and took out geographies with political instability -- like Russia and Brazil. We also focused on places where it's much easier for a company to justify a headquarters relocation, like Ireland or The Netherlands.
We also took out industries like banking and utilities that have a lot of complex regulation, and focused on industries that have a lot of history with inversions and acquisitions, like oil and gas and pharma. We also have a number of technology companies as well, where if the acquisition of the technology makes sense, the inversion might also make sense.
Walia added that the companies held are equal-weighted, meaning that the acquisition of a smaller company provides roughly the same upside as that of a larger organization. The motif will be rebalanced quarterly based on acquisition activity.
I asked whether inversions are a sustainable trend for investing, and Walia pointed out that corporate inversions are more popular than ever. So far in 2014, there have been a dozen inversion deals. He also thinks that without a major shift in the political picture in Washington, it's hard to foresee any meaningful legislation that makes inversions difficult or lowers U.S. corporate tax rates.
Additionally, more companies are becoming less dependent on the U.S., which will lead to more relocations abroad. Furthermore, U.S.-based companies have as much as $2 trillion overseas, making international acquisitions even more appealing because the cash to buy these targets doesn't have to be repatriated to the U.S. A recent example is Microsoft's $2.5 billion deal to buy Swedish Mojang AB, maker of the hit video game Minecraft. Like many technology companies, Microsoft has a lot of money overseas -- about $70 billion as of this past March.
Is this a good way to profit from inversions?
Honestly, it's tough to say. A lot of speculation has to be baked into a strategy like this, and the value of the investment will still be largely driven by the performance of the companies held in the motif versus a handful of potential acquisitions. With that said, if you're interested in trying to profit from this trend, Motif could be providing investors with the simplest way to do so.