reverse takeover or financial “inversion”

This is a followup to yesterday’s post, in which I commented that there’s something wrong with the US Federal corporate tax system.

One of the symptoms is the growing use of a type of reverse takeover, called an inversion, by US corporations to lower their taxes by shifting their headquarters internationally.  No one has to move; this is simply a legal change.

I don;t think US companies necessarily want to do this, but–aside from a few heavily tax-subsidized industries–US corporate taxes are considerably higher than those in other countries.

how a reverse takeover works

Let’s say Company A buys Company B.

In a plain vanilla , and simplified, version of the takeover/merger:

–the management and shareholders of Company A maintain control of A and add control of the combined A + B

–legally, Company B either becomes a subsidiary of Company A, or the assets of Company B are folded into Company A and

the empty shell of Company B goes out of existence.

In a reverse version of the same takeover/merger:

–the management and shareholders of company A still take control of A + B, but

–legally, the assets of Company A are folded in to Company B.  The original company A goes out of existence.  Often, B renames itself “A,” so that no one on the outside can tell that anything has changed.

why do a reverse takeover?

Why go to the extra legal trouble?

historically…

…a big reason has been to allow a private company to go public quickly.  The private company locates a moribund firm with few assets–sometimes called a shell company–that already has a public listing.  By buying it and executing a reverse merger, the private company ends up with its assets and operations inside the “clothes,” as it were, of the public firm.  All at once, it has a public quote, and  –this is the important thing–it has not had to go through the often lengthy regulatory scrutiny involved in an IPO.  Many Chinese firms, for example, have taken this route to public listing in the United States.

…and now

In recent years, this process–now termed an inversion–has been used by US companies buying foreign firms.  Many have been pharmaceuticals buying European counterparts.  The surviving legal entity has virtually always been the European firm, even though the Americans are in control.

Why do this?

Although the firms may say otherwise, I can’t help believing it’s to shift the company’s tax home away from the US, where corporate taxes are unusually high for health care.  The corporate tax rate is 35% in the US vs. 12.5% in Ireland, for example.

Walgreen

…which brings us to US drugstore operator Walgreen (WAG).  WAG is acquiring the Swiss-based drugstore chain Alliance-Boots.  According to the Financial Times, investors who in total own about 5% of WAG, including Goldman Sachs and  Jana Partners, are urging the company to redomicile to Switzerland.  Doing so, the investors say, would reduce the corporate tax rate from WAG’s current 37.5% to something closer to the 20% Alliance-Boots now pays.  If so, the move would increase WAG’s after-tax earnings by 80% or so–slashing the stock’s PE multiple to less than 14.  That would be considerably below the S&P 500 average.

Since in today’s world investors rarely look at a low tax rate as a negative, zeroing in almost exclusively instead on EPS, WAG shares would presumably rise to restore the PE either to its previous level or at least to the market average of about 17.  At the very least, WAG could boost its dividend substantially.

WAG probably won’t heed the Goldman/Janus advice, for fear Congress would have a fit.  Still, the “brain drain” will likely continue unless/until Washington overhauls the income tax code.

 

 

 

 

 

 

2 responses

  1. As a merchant banker providing “work out” services and “go public” projects that sometimes employ reverse mergers, I appreciate your description (no negative implications, just process). I think that the drain of large multinational companies re-domiciling to Europe and small islands is a huge problem brought on by U.S. politicians lack of restraint on spending – increasingly they have depended upon taxing everyone, including corporations, to support larger and larger government. Until this stops, the tax man cometh and large corporations with heavy tax burdens will continue to flee these shores.

    Sad. Post WWII, corporations around the world came here to flourish, now our own companies are fleeing…

  2. Thanks for your comment.

    I agree. While I was writing this, I was thinking about when I started looking at Pacific Basin economies in 1984. Both Australia and New Zealand were experiencing incredible brain drain as high personal income taxes–marginal rates higher than 60%–spurred ambitious young business people to emigrate.

    There was also a time in the UK–pre-Margaret Thatcher–when individual tax rates were so high (75% or more) that companies began to buy bespoke suits and rent them for nominal sums to senior management rather than give them raises, almost all of which would go to the (then) Inland Revenue.

    You know something is wrong when stuff like this happens–as is now happening in the US.

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