In a bid to lower corporate tax rates and recapture cash-trapped overseas, U.S. companies are rushing to orchestrate deals with overseas competitors.
Mylan (NASDAQ:MYL) is the latest company to embrace the tax-busting tactic, by agreeing this week to form a new Netherlands-based company that will not only include its existing business, but a sizable chunk of Abbott Labs (NYSE:ABT) drug business, too.
First, a bit of background
Abbott Labs has been searching for ways to boost its growth rate since separating from AbbVie in early 2013. Abbott's postsplit business includes four business segments, none of which posted year-over-year growth north of 5% last quarter.
One of those four businesses is its established pharmaceuticals segment, which comprises a portfolio of generic and specialty drugs sold in both emerging and non-U.S. developed markets.
Despite demographic trends supporting drug demand, this business didn't post year-over-year growth in the first quarter as weak results in Europe and Japan weighed down strong results in emerging markets including India and China.
While Abbott's drug business has stalled, Mylan's business continues to grow. The company is a dominant player in global generics, rolling out hundreds of new generic alternatives every year. As a result, Mylan's sales were roughly $7 billion in 2013 and sales totaled $1.72 billion in the first quarter, up from $1.63 billion last year.
Two birds with one stone
The transaction accomplishes some important objectives for both companies.
By selling its non-U.S. developed markets branded drug business to Mylan for shares worth around $5.3 billion, Abbott unwinds a low to no growth business that had been facing stiff price competition.
Although the deal reduces Abbott's earnings per share by $0.22 per share next year, it is expected to boost Abbott's future net income growth by 2% a year. Abbott plans to eventually unwind its 21% Mylan stake, which would give it more flexibility for buybacks or bolt-on acquisitions.
Meanwhile, Mylan gains immediate scale that it believes will generate $200 million in pretax operating efficiencies over the first three years. Importantly, Mylan investors will see the newly acquired portfolio immediately add to earnings per share. The company expects EPS will be $0.25 higher in the first year and is guiding for its EPS to increase through 2018 as those operating efficiencies are realized.
Mylan also gets the opportunity to convert itself from a U.S. company to one domiciled in Europe.
Mylan expects that this inversion will result in a tax rate in the 20% to 21% range immediately (down from about 25% today), with its tax rate settling out in the high teens over time. Since the U.S. taxes income overseas at U.S. rates (minus taxes paid in other countries) when it's brought back to the states, the deal should also give Mylan more flexibility in tapping cash generated overseas.
Fool-worthy final thoughts
Abbott and Mylan's deal gives investors in both companies something to like. Abbott gains flexibility and a faster growth rate and Mylan gets a solid cast of new products, a bump up in earnings and clarity into its future tax obligations.
But there is one big question mark and that's how long Abbott plans to stick around. Abbott's 105 million share stake in Mylan will be massive and given Abbott plans to sell, investors are right to wonder how Abbott will do that without sending shares lower.
Perhaps, Abbott will find a private equity firm or big pharma company to take the entire stake, but that's purely speculation at this point.