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?


…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.


…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.







average wages in the US are back to pre-recession levels …the point is?

Good news, but not great.

How so?

80% of the wage gains since 2008 have gone to the top 20% of wage earners, meaning those earning $190,000 a year or more (this is despite recent government allegations that top tech firms in Silicon Valley have conspired to hold down their employee wages).

In other words, the vast bulk of the workforce still isn’t as well off as six years ago.

In addition, the unemployment situation remains stubbornly high.

My conclusion is that what we have now is about as good as it gets in the domestic economy, without policy action from Washington.

Two data points suggest that structural changes in the world economy are at the root of a lot of this:

–the decline in the fortunes of the middle class in the US coincides with an improvement in the lot of the middle class in emerging markets, and

–anecdotal accounts are circulating of firms filling their vacancies by poaching from rivals, which would suggest we’re close to full employment.  I heard economist Paul Krugman the other day saying that the basic problem in the US is that there are too few jobs.  He means that necessity isn’t forcing employers to hire unskilled workers and train them.  In a sense, that may be right.  On the other hand, how long will it take and how much will it cost to train an average high school graduate to become a statistician or a web designer?   Why not relocate to a place where skilled workers are more plentiful and corporate taxes are lower (the latter meaning just about anyplace else)?

investment implications

The current domestic economic situation says, I think, that we should continue to focus on companies with worldwide, rather than simply US, businesses.  We should also avoid firms that cater to domestic customers with average or below-average incomes.  These will only be able to grow revenues by “stealing” them from competitors–persistent price wars will break out, in other words.

At the same time, this state of affairs has been around long enough that we should also be scanning the horizon for evidence of change.  I suspect that changes in education/training will come informally–not through intelligent government action–and will sort of sneak up on us.  On the other hand, reduction of the Federal corporate tax rate to a level more in line with the rest of the world would probably give a surprisingly large spur to job formation (more about this tomorrow).

Yahoo, welcome to France!


For the past half-year, Yahoo (YHOO) has been negotiating with France Telecom to buy a controlling interest in Dailymotion, an online-video website that FT acquired in 2011 for €127 million ($165 million).  According to the Wall Street Journalthe two parties reached an agreement last month in which YHOO would pay $225 million for 75% of Dailymotion, the 10th largest You Tube competitor.

This looked like a sweet deal for both sides.  FT would get all its cash back plus a profit and would retain a 25% interest in Dailymotion, while YHOO shouldered all the financial and operational burden of growing Dailymotion as fast as possible.  YHOO would take a big step forward in developing an online video arm.

redressement productif intervenes

Then Paris stepped in.  In a move reminiscent of its rejection of Pepsi’s bid to acquire yogurt-maker Danone, the parties were summoned to the offices of the French Minister of Industry (=redressement productif), Arnaud Montebourg on April 12th.  Le Monde says M. Montebourg yelled at FT, described Dailymotion as a national treasure that must remain in French hands and vetoed the deal.

Odd behavior for an official who is a central figure Paris’s campaign to convince foreigners to invest in French companies (“Say Oui to France, Say Oui to Innovation”).  On the other hand, this is France we’re talking about.

damage done

This government move has bad consequences both for France, and for Dailymotion:

–Dailymotion is now stuck being a part of a telephone utility, which doesn’t have the skills, connections or capital to help it grow.

–Dailymotion employees see that their dreams of making a large profit by cashing out in a sale, or of being key figures in a large internet entity have gone up in smoke.  The most talented are doubtless already cutting their losses and leaving France for tech jobs elsewhere.

–Paris has just shown foreigners that any capital they put into France is subject to the whims of the ruling elite and could easily be trapped there forever.   M. Montebourg’s public post-meeting gloating about his action only reinforces this idea.

–the move is another significant step down the path to economic irrelevance blazed by Japan.

France is not the only chauvinist…

…although it is the birthplace of the Nicholas Chauvin legend.

Every country restricts foreign investment to some degree.  Almost no one lets non-citizens control essential industries like defense, telecommunications or media, for example.  Developing economies, fearing that rich foreigners will spirit away local businesses on the cheap, often enact wider restrictions.  Continental European nations, where preserving the position of a small group of “haves” is a very high priority, do the same.  The US, fearing its growing economic power, won’t let China buy much of anything.


M. Montebourg seems to have no clue that he has highlighted the negative reality behind the “Say Oui to France-innovation” campaign.

The campaign’s website, which I thought was well done, features prominently an explanatory video driven by the same Dailymotion Montebourg has just eviscerated.

The French love to disparage American intellect and culture.  According to one recent description, we have been mentally ensnared by our greatest creation, Disneyland, and are now unable find our way back to the real world.  They don’t seem to get it that venerating yogurt and online videos suggests you’re a lot more confused than we are.   Or that being lost in memories of the glory of the Ancien Régime is not such a hot thing, either.

noodle making returning to UK from China–what this means

noodles to Leeds

British Food company Symington’s, the inventor of pea flour and maker of Golden Wonder’s pot noodles, is returning its noodle manufacturing operations from Guangzhou to Leeds, according to the Financial Times.  The FT says the company cites equivalent/lower labor costs in the UK and better response times to customers’ requests as the main reasons.  (I’ve looked in vain on the Symington’s website for a press release.)

This says something about China.  

But it’s not new news.  Alerted by Hong Kong-based distributor Li and Fung and by David Pilling of the FT, I wrote  in late 2010 about the shift of labor-intensive manufacturing, like t-shirt making, away from China to places like Bangladesh and Vietnam.  As I commented back then, this wasn’t particularly new news in 2010, either.

China has run out of cheap labor on its eastern seaboard, a signal that at least this region of the country has to shift to higher value-added manufacturing.  The textbook solution for a nation facing this issue is to allow its exchange rate to rise, while holding local currency wages steady.  China, however, hasn’t followed the schoolbooks.  It has kept its exchange rate relatively stable, while aggressively encouraging local currency wages to rise.  Although this also gets the job done of forcing the most labor-intensive and low value-added businesses to go elsewhere, it runs the risk of creating a lot of inflation.  We’ll see how things turn out.  But, personally, I’m not betting against Beijing on this one.

What’s more interesting, to my mind, is what this says about the UK

Yes, the home country has won back the noodle makers.

There certainly are transportation time and cost savings.

Symington’s will doubtless use “Made in the UK” to its marketing advantage.  And there are probably political points being scored as well.

Nevertheless, this isn’t wresting high-tech business from Google, or Samsung or Amazon.  It isn’t bio-tech.  It isn’t competition for LVMH.  It’s labor-intensive work that would otherwise have ended up in a developing country further down the food chain than China.

“Reshoring” of this type is a two-edged sword.  On the one hand, it’s an illusion-shattering phenomenon for dreamers who recall the days when Britain held a privileged place as the manufacturing hub for a far-flung colonial empire–including Bangladesh.  On the other hand, it’s a place to start.  And with sterling gradually depreciating, UK labor will be in increasing demand.

as an investor…

…this may not be great news for UK manufacturing.  Nor is it a reason to be interested in this sector, because profits are likely to be slim.  But even a low-end manufacturing revival means more jobs.  That suggests that mid- to low-end entries in consumer-oriented areas like lodging, specialty retail and supermarkets may have better prospects than is currently factored into their share prices.

the fiscal cliff: why not just raise income tax rates?

There are several arguments–some theoretical, some the fruit of bitter experience–against raising income tax rates beyond a certain level.

To be clear, personally I don’t think they apply in the present argument about how to close the current US annual $1 trillion+ Federal deficit.  After all, the country seemed to run perfectly fine in the 1990s, when rates were higher.   So I don’t see how turning the clock back to the status quo ante can be so bad.  (Following that logic would also imply rolling back the extra healthcare benefits enacted at the same time.)

I suspect that the biggest stumbling block is that patronage politicians know very well how to divide up shares in an ever-expanding economic pie (who wouldn’t?) but are incapable of agreeing on how to apportion mutual sacrifice.  It doesn’t help matters that, in my view, Republicans have an antediluvian economic philosophy and Democrats have none.

Nevertheless, there’s a limit to how high rates can be pushed.

how can higher tax rates be bad?

When rates reach a certain point:

1.  people start to work less.  I had an eccentric uncle (one of my favorites) who quit his brokerage house back-office job (the only position Irish Catholics would be hired for) and supported himself for the rest of his life investing his own portfolio–turning $400 into $1 million+.  Why leave?  …he was so incensed at the income tax he was paying on overtime.  Uncle Harry wasn’t your typical worker.  But if you’re losing, say, 70% of your incremental income to the tax man, what’s the point of doing extra work?

2.  people spend increasing amounts of time on gaming the tax code, diverting economic energy from more productive uses. Behavior can get crazy.  In the UK in the early 1980s, companies were buying suits and renting them to their executives rather than giving pay raises, because the tax on incremental individual income was so high.  If history runs true, the loophole-ridden US tax system would spawn huge amounts of new tax shelters–very profitable for promoters, disastrous for the purchasers.

3.  tax avoidance accelerates.  I was sitting next to the Spanish finance minister at a lunch early in my career.  I naively suggested that his country would have to raise income taxes in order to close a troublesome budget deficit.  The minister looked at me like I had dropped from the moon.  He explained that income tax rates in Spain were already as high as they could go.  Experience showed that pushing them higher resulted in lower tax receipts.  Very many people would begin to hide substantial amounts of their income from official eyes through off-the-books transactions.

4.  people leave the country.  In the US, we can see this behavior on the state level, in the steady migration from high-tax areas like New York, New Jersey or California.  France, which has recently raised the top income tax rate on high earners to 75%, is now seeing the wealthy starting to renounce their French citizenship and move elsewhere in the EU, like the UK or Belgium.

Macau gambling crackdown?

The Financial Timesamong others, ran stories yesterday attributing the sharp, across the board fall in Macau casino shares in Hong Kong Tuesday to the detention by Chinese authorities of several junket operators who organize groups of high roller gamblers travelling from the mainland to the SAR to gamble.  Government inquiries have apparently also been made to the casinos themselves for information about the structure and betting behavior of some junkets.

To my mind, it’s not yet clear what’s going on.  The possible government concerns, as I see them, might be:

–displays of affluence in a socialist economy.  This has never bothered Beijing before, so I doubt this is the issue now, other than as a formalistic expression of official disapproval.

–possibly illegal flow of foreign exchange out of China.  This is a perennial problem for any country with foreign exchange controls.  The time-honored method of moving funds abroad, however, is through corporate transfer pricing.  But there’s no evidence of a wider crackdown, so I don’t think this is the issue, either.

–money laundering.  This was a notorious problem while Macau was a Portuguese colony, and while the former casino incombent had a monopoly on legal gambling.  Money of dubious origin enters the casino and leaves as legal, taxable gambling winnings–with the casino serving much the same function that urban parking lots sometimes serve on a smaller scale.

This is a serious issue.  In my view, eliminating criminal influence in the Macau casino industry is the prime reason the Macau SAR granted gambling concessions to Wynn Resorts and Galaxy Entertainment.  I’d be surprised and disappointed if Galaxy, Sands or Wynn were involved in money laundering.  Authorities have apparently contacted all three for information, however.

–defining political have-nots.  It seems that a lot, if not all, of the regulatory attention has been focused on associates of the disgraced former head of Chongqing, Bo Xilai, whom Beijing regarded as a threat to the stability of the Communist Party.

my take:  my guess is that what’s going on is some combination of #3 and #4 and that any investigation will end up having little negative impact, if any, on Wynn Macau, Sands China or Galaxy.  But I have no hard facts to base this view on.  So my reaction is to trim my positions–the Hong Kong stocks have been very strong performers recently–and wait for further clarification.

comparing Japan 1992 with the Eurozone 2012

creating an EU timetable

It seems to me that all of the elements of the Eurozone crisis have been out in the open for some time.

The Papandreou government took power in Greece in September 2009 and triggered the crisis by announcing that the national accounts had been falsified for many years by the prior administration.  Greece, as many had already suspected, was in much worse financial shape than the official figures showed.  But that was 33 months ago!

It has been clear from the outset that financial contagion could easily spread from one member of a currency union to the others.  The rolling nature of the Asian financial crisis of the late 1990s showed vividly how this could happen, even outside a tight economic linkage of the typce that binds the Eurozone together.

It has also been evident from the beginning that the Eurozone banks were intimately tied to the weaker countries by their large holdings of those countries higher-coupon sovereign debt.  So they were in trouble, no matter what country they were domiciled in.

We’ve also seen the shoes drop, one by one, as market attention has shifted from Greece to Italy to Spain, just like in Asia–and the PIGS countries have revealed the extent of their financial messes.

We’ve recently seen capital flight, as corporate and individual investors have (sensibly) shifted their euros from banks in weaker countries to those in Germany or other stronger ones.

Finally, I think we’ve reached a political tipping point in Germany, where the political cost of not addressing the woes of southern Europe exceeds the cost of taking action.  Hence the recent moves to consider more than austerity as a solution.

for investors, where to from here?   

I’m looking at the situation as a foreign investor, not as a citizen or resident of the EU.  I’m more concerned with the stock market implications of today’s Eurozone situation than the political and economic.

My question, then, is:

when will the EU’s fiscal problems stop being the dominant factor influencing the movements of its stock markets–and the markets of the rest of the world?

looking at Japan in 1989

We do have one example of this kind of situation during my professional lifetime.  It’s the Japan of late 1989.

That’s when the new head of that country’s central bank began to raise interest rates to force the government to bring highly speculative banking and  financial market activity under control.  The subsequent failure of Tokyo to fix its broken economy ushered in the first of Japan’s two (so far, at least) Lost Decades.

To my mind, Japan’s case was at least as bad as the EU’s.  And Japan more or less deliberately–but very clearly–made a bad choice.  It opted to cover up its problems to preserve a traditional way of life and a traditional power structure, rather than to evolve in a way that would gradually fix them.

It’s not a great roadmap, but it’s the best we have.

what happened in the Tokyo stock market?

The main indices peaked in December 1989, as rates began to rise.

They fell until June 1992, 31 months later.

From that point, the Japanese market drifted, with high volatility, for the remainder of the decade.  This ran counter to a rising trend in the equity markets of other industrialized countries.

The most sobering news is that today, twenty years after the initial bottom, the Tokyo market hasn’t recovered an ground.  On the contrary, it’s half its level of June 1992.  Today, it’s an investing backwater, lost in dreams of the 1980s, and with highly restrictive rules against any foreign attempt to change the status quo.

my conclusions

If Japan is any guide, we should be close to the end of the initial downward phase in Europe.  To me, it makes sense to be on the alert for signs of stabilization.

In Japan, the strongest stocks by far after the initial bottom were either multinationals or export-oriented firms.  That is, they were companies headquartered in Japan but with their operations elsewhere.  To the extent the Japanese citizens bought stocks during the first Lost Decade, those are the ones that they–as well as foreigners–favored.  I think the same will be true in the EU.  Companies located in the EU but not in the Eurozone will probably do the best.

The crisis was by no means over in Japan in mid-1992.  In fact, the first inning had barely begun.  But Japan’s problems ceased having a major negative influence on other markets.

Europe is much more entwined in the fabric of world commerce than Japan was in 1992.  The EU may have a tougher time than Japan over the coming years, in the sense that world economic growth will likely not be as strong as it was in the second half of the 1990s.  On the other hand, Japan benefited less from strength elsewhere than the EU is likely to do.  So a general picture for EU stocks–in the absence of a dramatic political evolution of the EU–is probably flattish, with a lot of volatility.

On the crucial question of whether the EU will follow Japan down the same path to economic irrelevance I have no answer.  I didn’t think Japan would be as inflexible as it has been.  But it shows that when a country has deeply ingrained notions of its cultural superiority and the interests of the status quo are very powerful, denial may be the easiest road to follow.

My bottom line:  it’s probably safe to dip a toe in the EU water today, but not much more than that.

A final note:  once Europe leaves center stage, I think market focus returns to economic policy in the US.