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A Postcard From Berlin

Returning to Berlin for the first time in several years, it is remarkable to see this great city progress as the cultural center of Germany. Penny and I had the privilege of staying at the magnificent Adlon Hotel as our hotel room looked out on Brandenburg Gate, the former dividing line between East and West Berlin. I still have vivid memories of standing under the gate on October 3, 1990 – the day of German reunification – when Maestro Leonard Bernstein conducted the Berlin Philharmonic playing Beethoven’s 9th Symphony with its glorious “Ode to Joy.”

Some thoughts on our impressions of Berlin circa 2014:

  • I wish I could have been here on Sunday, July 13 for the spectacular triumph of the German soccer team as 250,000 Germans watching on large screens on Unter Den Linden saw young Mario Götze’s brilliant goal in the 113th minute to bring the World Cup back to Germany.
  • Two days later 400,000 Germans gathered to greet their heroes as the team arrived home from Rio. Prior to landing at Berlin’s Tegel airport, their airplane did a flyover and wiggled its wings to salute the cheering masses. What a contrast with the 1930s ...
  • Speaking of the 1930s, German contrition and ownership of the terrors of the past are present everywhere, but no more apparent than at the stunning and horrifying Topography of Terror. This museum documents the shame of the past without pulling any punches. Just one block from Brandenburg Gate is the haunting Holocaust Memorial, with its images of large blocks protruding from the grounds (representing those who died in the Holocaust?). As horrifying as these monuments are, one has to credit the German people for owning the sins of their past. Where in the U.S. can one find an owning of our past of destroying Native American cultures (or attempting to do so) or bringing slaves to our shores in chains? Or in Russia of the 25 million people “eliminated” by Joseph Stalin?
  • These monuments constitute but a small fraction of the architectural wonders of Berlin, as many of the world’s greatest architects have come here with the freedom to showcase their greatest creations – not the least of which is amazing Sony center. Berlin today is a modern, beautiful city that all Germans can be proud to call their capitol.
  • I have long admired the German economic miracle which has occurred since the rapprochement in the past decade, thanks to the leadership of former Chancellor Gerhard Schröder. He brought together business, labor and government leaders to act in concert to build the German economy. The result of their efforts has been years of improved competitiveness, thanks to highly skilled workers, flat wages and benefits, low inflation, and net exports exceeding $200 billion – a sharp contrast to the U.S.
  • Now there are cracks appearing in the vaunted German resolve, as wages are rising again at 3-4%, well above Germany’s low inflation rate of 1%, and German industry finds itself far too dependent on Russian gas that costs three times the price paid by its U.S. counterparts. Meanwhile, a rift is emerging between complacent German politicians and German industrial CEOs forced to expand outside Germany in order to remain competitive. How will Germany resolve these differences? We left Berlin without any clear answers to this question, in spite of asking many leaders to respond to it. One hopes that Germany will continue to be  not only the leader of Europe, but a role model for all industrial nations, including the U.S.
  • Meanwhile, one of the weaknesses of the German economy – the lack of entrepreneurship and risk-taking – does not appear to be any closer to resolution than it was a decade ago. Time and again, we were told of the fear of failure that so many German leaders have and their unwillingness to embrace the kind of innovation so commonly seen in Silicon Valley due to the personal risks involved.

While Germany has its share of challenges, they pale by comparison with the political gridlock we face in the U.S. I have the clear sense that the diligence, commitment, and pragmatism of Germany’s business, government and labor leaders, and the strong sense of unity among them, will enable Germany to resolve the issues it faces, and continue to be a strong, competitive player on the world scene – and a role model for all developed economies.

The Boston Globe: More US firms chase mergers that yield overseas address

Good article from The Boston Globe on the renewed interest in "tax inversions," and my thoughts on why acquisitions must never be just about driving deals.

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From The Boston Globe, by Robert Weisman, Tracy Jan, and Jack Newsham (July 13, 2014)

When Flemming Ornskov was named chief executive of Shire PLC last year, he moved his office from the drug maker’s Dublin headquarters to its Lexington campus so he could scout for biotechs to buy here.

Now Shire itself is a takeover target. It rebuffed a $46 billion bid from pharmaceutical giant AbbVie Inc. of Chicago late last month, but the suitor hasn’t given up. It’s not only after Shire’s drug portfolio, but also the company’s address in Ireland, where corporate taxes are lower.

The AbbVie move came less than a week after Medtronic Inc. agreed to pay $42.9 billion for Covidien PLC., a supplier of health care products that bases its corporate staff and US headquarters in Mansfield. But like Shire, Covidien calls Ireland home for tax purposes. 

“It’s becoming increasingly disadvantageous to be a US-based multinational,” said Eric Toder, codirector of the Tax Policy Center, a nonpartisan Washington, D.C., think tank. “So what’s the solution? You stop being a US-based multinational.”

And that’s what many American corporations are doing. Over the past decade, 40 of them have moved abroad to save money — hundreds of millions of dollars annually, in some cases — while keeping the bulk of their operations here. Covidien, for instance, has nearly 14,000 employees in the United States, including 1,800 in Mansfield, but only about 1,400 in Ireland. Shire, for its part, has about 1,500 workers in Massachusetts and just 100 in Ireland.

At a time when merger activity is rising, tax professionals are reporting a “renewed interest” in so-called tax inversions, under which US companies shift their corporate bases to Ireland or some other tax haven, said Daniel Berman, a principal at the Boston offices of accounting firm McGladney LLP and a former US Treasury official.

But there is also a backlash building in Congress and among some business leaders against businesses shopping for tax-light locales.

Two members of the Massachusetts delegation, Senator Elizabeth Warren and Representative Richard Neal, have signed onto Democrat-sponsored bills in the Senate and the House that would tighten rules for companies that reincorporate overseas to avoid paying US taxes.

“This is one more example of Washington working for those who can afford to have armies of lobbyists and lawyers,” Warren said. “Big corporations are using the tax inversion loophole to juice their profits and avoid paying billions of dollars, while working families are forced to foot the bill.”

The bills on Capitol Hill call for a two-year moratorium on tax inversions. Michigan Democrat Senator Carl Levin, the Senate bill’s primary sponsor, describes them as “tax avoidance, plain and simple.” The legislation would also prohibit companies from shifting their tax addresses overseas if management and significant business operations remain in the United States. Republicans, who have not signed on to the bills, say it makes more sense to instead cut US corporate tax rates.

Meanwhile, at a Harvard Business School gathering last month that included chief executives from about three dozen top US companies, former Medtronic chief executive Bill George, now a Harvard management professor, called on businesses to rethink tax inversions.

“You have to run your global company for all its stakeholders,” George said in an interview. “That means the customers, the employees, the shareholders, and the communities you reside in. You have to be a pragmatist. These tax inversions are driving some deals. If that’s the primary rationale, you’re asking for trouble.”

George criticized pharmaceutical giant Pfizer Inc., which opened a large research center in Cambridge this month, for citing a planned tax inversion as a major reason for its $119 billion offer in April to buy London-based drug maker AstraZeneca plc, an overture that was rejected. AstraZeneca also has a Massachusetts research lab in Waltham, so had the deal gone through, the combination could have resulted in consolidation and layoffs there.

“If you’re just cutting jobs to reduce costs, that’s a one-time thing,” George said. “An acquisition has got to be good for your employees. Otherwise, you kill their motivation.”

Another growing Massachusetts biotech, Waltham-based Alkermes, bought Ireland’s Elan Drug Technologies in 2011 and promptly shifted its own headquarters to Dublin. Chief executive Richard Pops said at the time the deal wasn’t done to lower taxes — Alkermes wasn’t profitable then — but he acknowledged there would be future tax benefits.

Ireland maintains a corporate tax rate of 12.5 percent compared with the United States’s 35 percent, one of the highest rates in the world. Because of that, US companies hold about $3.5 trillion in corporate cash in offshore accounts, according to George. The money comes from sales of their products in foreign countries.

To use that cash in the United States for building plants, buying equipment, or hiring workers, companies would have to pay the 35 percent rate as a “repatriation” tax. The former Medtronic chief has called for a one-time holiday on repatriating money held abroad, but he admits it would be a temporary solution.

“Our tax rates are out of line with the rest of the world, so companies are leaving,” George said. “It’s tragic.”

Many believe a long-time solution must revolve around reforming US corporate tax policy.

“The problem is caused by US taxes being higher than everybody else’s,” said Joseph B. Darby III, a partner at Boston law firm Sullivan & Worcester. If you’re a US company, you’re a “tax prisoner,” he said.

As for the Democratic bills in Congress, few think they stand much of a chance. “I don’t think people are paying much attention to legislative proposals,” Berman said. “Congress is not in much of a position to enact tax law these days.”

Ireland also is examining ways to discourage mergers that do not involve “real substance in terms of jobs and investment in the Irish economy,” Ralph Victory, spokesman for the Irish embassy in Washington, D.C., said in an e-mail.

Covidien, formerly known as Tyco HealthCare, set up shop in Ireland shortly after former parent Tyco International spun it off in 2007. But unlike their counterparts at Pfizer, Covidien and Medtronic executives downplayed the tax benefits, saying the merger was driven by “complementary” businesses.

Neal said he spoke with Covidien chief executive Jose Almeida recently and is convinced the takeover was not based solely on tax savings.

“Seeking a favorable tax treaty is a bit different than going to Bermuda and renting a post office box,” said Neal, who in 2004 sponsored legislation that was able to stop many inversions from occurring at the time. “There is a difference between tax avoidance and tax evasion. But . . . the imminent danger here is you now have up to 50 other companies considering the same inversion process.”

Bill & Penny George Receive Reach for the Peak Award

On Thursday, July 10, Penny and I were honored to receive the Reach for the Peak Award from Walking Mountains Science School in Vail. Here’s the video they produced for us. https://vimeo.com/100357007

Recommendations for Medtronic Shareholders

Sunday’s Minneapolis Star-Tribune contained a thoughtful article by Jennifer Bjorhus articulating concerns over capital gains taxes that Medtronic shareholders must pay when Medtronic completes its acquisition of Covidien.

As a long-time holder of Medtronic stock, here’s what I am planning to do and what I would suggest for other Medtronic individual shareholders:

  1. The easiest approach for Medtronic shareholders is to sell just enough stock to pay for the capital gains taxes, which will be 20% of the net gain to cover federal taxes. For Minnesota residents, there will be an estimated additional 8% tax depending on your income bracket. This must be done prior to the closing of Medtronic’s acquisition. Here’s my rationale: Medtronic stock is at an all-time high, so this is a good time to sell enough stock to cover your taxes. For example, if you bought your stock three years ago when Omar Ishrak became CEO, your gain is 65%. If you sell enough stock to cover the 28% tax, you still have a 45% gain in your stock value – not bad for a three-year investment – and no future capital gains taxes will be due on your 45% gain.
  2. If you can afford it, here’s an even better option that Penny and I plan to follow: give a significant portion of your stock away to your favorite charity or religious organization. Penny and I plan to give our Medtronic stock to the Penny George Institute Foundation (PGIF) at Allina Health, Plymouth Congregational Church, Georgia Tech (my alma mater for my 50th reunion), and the George Family Foundation. We plan to do this before the closing to avoid capital gains taxes. Then we will buy additional Medtronic stock in the open market as we believe Medtronic stock will be an excellent investment for many years to come.

For those of you who are interested in investing in health care and integrated medicine, here’s an additional opportunity to double your investment if you donate to the Penny George Institute Foundation: Penny and I will match any contributions of Medtronic stock to the Institute for the remainder of 2014. If you pursue this approach, you will receive a tax deduction for the full amount of your gift and avoid the capital gains tax, plus your gift will have double the value through our matching contribution.

For example, if you donate 100 shares of stock at the current market price of $64, you receive a tax deduction of $6,400 plus you avoid capital gains taxes, estimated at $720 if you bought three years ago. With our match, your gift will double in value to $12,800 for the Penny George Institute. (For more information, contact Stephen Bariteau at PGIF (Stephen.Bariteau@allina.com).

While none of us likes to be forced to pay taxes, the above approaches suggest there are ways to avoid any financial burden these capital gains taxes may impose, and potentially do a lot of good at the same time.

Thank you for considering these options.

StarTribune: Bill George: Tax inversion deals should make sense beyond just taxes

From StarTribune, June 28, 2014

With Medtronic’s $43 billion acquisition of Covidien, Pfizer’s failed $119 billion bid for AstraZeneca, and AbbVie’s pending $46 billion proposal for Shire, conflicting opinions abound about the merits and drawbacks of tax inversions. Some consider them unpatriotic. Others believe companies are bound by fiduciary responsibility to consider them.

My conclusion: Companies that do deals primarily driven by tax considerations are headed for trouble. This lets the tail wag the dog. The only justification for a merger or acquisition is to strengthen your company’s strategic position. That’s what motivated Medtronic CEO Omar Ishrak to pursue the Covidien acquisition: The companies fit together perfectly.

Here are five tests that boards of directors should satisfy before approving any deal:

Does the acquisition further your company’s mission? Your mission should provide purpose beyond financial returns that creates value for customers, employees, shareholders and other stakeholders. Most important, it should motivate employees to create innovations and deliver great service far more than financial incentives.

Does it advance your global strategy? If companies want to expand into higher growth markets, acquisitions can accelerate their growth. If its strategy is emerging market growth, acquisitions can provide greater presence. Sound acquisitions can also strengthen new-product pipelines.

Does it motivate your employees and the acquired company’s? Sustained value creation only occurs through dedicated employees working together to advance the company’s mission. The key is to engage employees of the newly acquired company to commit to their new owner. That’s what Medtronic did a decade ago with its acquisitions of Sofamor-Danek, AVE, and Mini-Med, as employment tripled. Acquisitions also create personal growth opportunities for current employees.

Will the acquisition lead to sustainable earnings growth? The acquisition should be accretive to earnings within two years, including realistic cost-saving synergies, without cutting back investments in future growth. Acquisitions like Valeant’s proposed hostile takeover of Allergan, which is based on cutting R&D spending from 17 percent of revenue to 3 percent, fail to produce sustainable earnings growth.

Pfizer erred in betting entirely on cost cuts to justify $240 billion it spent to acquire Warner-Lambert, Pharmacia-Upjohn and Wyeth. As a result, its shareholder value declined 32 percent in 14 years. In its failed bid to acquire AstraZeneca, the latter’s shareholders were extremely wary of Pfizer’s tactics.

Can the acquisition be funded without putting your balance sheet at risk? Successful acquisitions must generate future cash flow to repay the investment. These days borrowing money is cheap due to low interest rates, but companies shouldn’t get overleveraged in case of economic downturns, as they did in 2008-09.

What about taxes?

Taxes are the No. 1 question on everyone’s mind with Medtronic’s acquisition. After the company answered the first five questions affirmatively, it sought ways to finance it utilizing $14 billion in trapped cash. The tax inversion gave Medtronic access to these funds and also $7 billion in annual cash flow after the acquisition closes.

Do companies have an obligation to repatriate overseas earnings and pay the additional 35 percent in U.S. taxes? Not in the opinion of CEOs and CFOs. That’s why U.S.-based corporations are keeping foreign earnings abroad, leaving over $2 trillion in cash trapped overseas.

The U.S. already has the highest corporate tax rate in the world, which is a significant competitive disadvantage to U.S.-based global companies. To access overseas cash, even for domestic investments, there is a significant incentive for tax headquarters to migrate abroad. The ideal solution is for Congress to rewrite the corporate tax code. But given the stalemate that currently exists in Washington, a tax bill is highly unlikely before 2017.

In the near term, President Obama should declare a six- to 12-month “repatriation holiday,” enabling companies to bring cash home tax-free provided they present plans to reinvest the funds in capital expenditures, R&D, job creation and new ventures. I have recommended this approach since 2010. So far, nothing has happened. As a consequence, U.S. companies are finding alternative approaches such as tax inversions. Otherwise, they are in the unenviable position of being worth more to a foreign buyer than to their own shareholders.

Bottom line: Tax inversions should only be considered after the first five tests are answered satisfactorily.

StarTribune: Counterpoint: Medtronic's move will benefit all

From StarTribune, June 23, 2014

COUNTERPOINT

Medtronic’s move will benefit all

The headline in the Opinion Exchange section June 22 trumpeted: “It’s shareholders over stakeholders for Medtronic.”

Nothing could be further from the truth.

Commentator Stephen B. Young fails to comprehend that Medtronic’s acquisition of Covidien is being done precisely to benefit all of its stakeholders: customers, employees, shareholders and communities. Medtronic CEO Omar Ishrak justifies the Covidien acquisition because it extends Medtronic’s mission to 5 million more patients annually. Let’s examine the actual impact on stakeholders:

Customers: Since 1989, Medtronic has expanded from restoring 300,000 patients annually to 10 million today. With Covidien, 15 million patients will be restored annually. Combined R&D budgets of $2 billion per year will produce breakthrough therapies to help more patients. The combination gives Medtronic nearly $4 billion in emerging market revenues to make its therapies more affordable and this enables it to serve U.S. hospitals more efficiently.

Employees: The acquisition gives Medtronic 87,000 employees who enjoy good-paying jobs, health care and retirement, including 9,100 in Minnesota. Ishrak also committed to adding 1,000 more jobs locally, causing Gov. Mark Dayton to applaud the deal.

Shareholders: Since the announcement, shareholders have signaled their approval, bidding up Medtronic stock 5.2 percent. Since Ishrak became CEO in 2011, Medtronic stock is up 65 percent.

Communities: Medtronic has long been dedicated to building its communities, giving 2 percent of its income to philanthropic causes. Additional profits will expand its giving.

Much attention has been focused on Medtronic’s decision to relocate its legal domicile to Ireland. This shift won’t change its 18 percent tax rate, but gives Medtronic access to $14 billion in cash trapped overseas plus future cash flows of $7 billion annually. Medtronic already has paid local taxes on these earnings, so it isn’t avoiding taxes on them, and it continues paying U.S. taxes on all U.S.-generated revenues.

Medtronic has committed to reinvesting $10 billion of these funds in new ventures and technology acquisitions, because management believes the U.S. is the world’s best place to invest in medical technology and entrepreneurs pursuing innovative medical therapies.

The litmus test for me is: Would I have done this deal if I were still CEO of Medtronic? My answer is an emphatic “yes.” Credit Ishrak for having the courage to seize this golden opportunity to extend Medtronic’s mission and be a powerful voice in improving health care globally.

Bill George

The writer is professor of management practice at Harvard Business School, author of “True North” and former chairman and CEO of Medtronic.

Medtronic Deal Benefits All Its Stakeholders

The headline in the Op-Ed in Sunday's Minneapolis Star-Tribune blared, "It's shareholders over stakeholders for Medtronic." Nothing could be further from the truth. 

Medtronic's acquisition benefits all of its stakeholders: its customers, employees, shareholders, communities and society as a whole. I spoke at length with Medtronic CEO Omar Ishrak on Friday evening about these issues, as well as prior to the acquisition announcement. Omar is as committed to the Medtronic Mission as any CEO since founder Earl Bakken, myself included. For Omar, the Covidien acquisition expands the Medtronic Mission of contributing “to human welfare by the application of biomedical engineering to alleviate pain, restore health, and extend life” - to more patients. When Bakken penned the Mission in 1960, he intentionally covered all aspects of human health.

A Deal That Benefits All Stakeholders

Let's look at the impact on each group of Medtronic stakeholders:

Customers: When I joined Medtronic in 1989, the company was restoring 300,000 new patients every year to health. During the past 25 years that number has grown to more than 10 million patients per year. Now, with the Covidien acquisition, Medtronic will be able to restore more than 15 million patients annually. Patients will benefit enormously from therapies originally created by Covidien that treat cancer, gastro-intestinal, respiratory, peripheral vascular and neurovascular diseases. The combined company will have a Research & Development budget of more than $2 billion per year (5x the annual revenue of Medtronic when I first joined). This R&D capability will produce a wide range of new therapies that help patients in the years ahead.

To be clear, many of these therapies are innovations that create entirely new markets – restoring patients who otherwise had few alternatives. Adding Covidien's $1.6 billion revenues in emerging markets to Medtronic's $2.1 billion will enable the company to serve emerging markets at scale, making these therapies more affordable for all and expanding patient access to life-saving therapies.

Employees: When the acquisition is complete, Medtronic will employ 87,000 people with well-paying jobs and full health care and retirement benefits. Its home state of Minnesota will benefit from an additional 1,100 Covidien employees currently in Minnesota. All of these employees, regardless of origin, will be brought into the Medtronic Mission that offers them "a means to share in the company's success."

Moreover, the improved competitive position of the combined company will increase the long-term opportunities available for employees.

Shareholders: Since the announcement, Medtronic shareholders have enthusiastically embraced this deal, bidding up Medtronic stock $3.16 to $63.86, or 5.2%. That's in sharp contrast to most deals where shareholders sell the acquiring company's stock and buy stock in the acquired company. Six of the twelve security analysts recommending "hold" for Medtronic upgraded their recommendations to "buy." Of the 24 firms covering Medtronic, 18 now have "buy" recommendations, 6 "hold," and none "sell." Since Ishrak took over as CEO three years ago, the company's stock is up 65%. 

Cynics may say gains to shareholders don’t matter, but I respectfully disagree. Strong financial performance sustains a company’s ability to invest in the long-term.

Communities: Medtronic has long been dedicated to the Minneapolis community and all communities where it has large concentrations of employees, consistently giving more than 2% of its pre-tax income to philanthropic and community causes. In addition, Medtronic committed to add 1,000 new jobs in Minnesota as a result of the Covidien acquisition, bringing its Minnesota employment to 10,100. This caused Minnesota Governor Mark Dayton to say the deal is "good news for Minnesota."

The one community that will suffer is Boston, where Covidien headquarters will be closed, an inevitable consequence of acquisitions. However, Covidien's main business locations along with Medtronic's locations can anticipate continuing increases in employment through growth in their businesses. This projection is borne out by the three major acquisitions Medtronic did over a decade ago - Sofamor-Danek, Arterial Vascular Engineering, and Mini-Med - whose employment and R&D investments have tripled in Memphis TN, Warsaw IN, Santa Rosa CA, Galway, Ireland, and Northridge CA.

Society as a Whole: Throughout its 65-year history Medtronic has been dedicated to serving society by improving health for people with chronic disease through its innovative therapies. This acquisition will enable Medtronic to accelerate its new therapies through an expanded R&D budget, extend them to more people in emerging markets, and expand its commitment to make the health care system more efficient.

Addressing the Critics

There has been much focus—too much focus, I’d argue—on the tax structure of the deal, through which Medtronic will relocate its legal domicile to Ireland. In its latest fiscal year Medtronic paid $640 million in taxes, 18% of profits. By changing its domicile to Ireland, its tax rate will not change materially. Medtronic did not do the Covidien deal to reduce its tax rate: it will still pay full taxes on all income earned in the United States.

The change in domicile enables Medtronic to utilize the $14 billion in cash trapped overseas as well as invest the $7 billion in annual free cash flow it anticipates in the future. Medtronic had already paid tax on these earnings in the countries where revenues were generated so it is not avoiding taxes on them. Rather, it avoids a form of double taxation – paying the added 35% U.S. tax in addition to foreign taxes on the same revenues, an approach being followed by all other global corporations. Medtronic’s situation is quite common. U.S. companies—including Apple, Google, and others—have more than $2 trillion trapped overseas by the inability to repatriate their earnings without added taxes.

In an interesting twist, Medtronic has committed to reinvest $10 billion of these funds in the U.S. in new ventures, technology acquisitions, and venture capital - over and above its current strategic plans. Medtronic management believes that the U.S. is still the best place in the world to invest in medical technology and support entrepreneurs pursuing innovative medical therapies.

In contrast to the Star-Tribune column, the one group that could experience a burden from this deal are current Medtronic shareholders who will owe capital gains taxes when the acquisition is complete. Depending on the cost basis of their stock, this could be significant, as it is for my wife and me. We have devised a solution to this problem that other Medtronic stockholders may want to consider: give Medtronic stock away to philanthropic causes.

In our case we plan to give our Medtronic stock to the Penny George Institute for Health and Healing at Allina Health and to the George Family Foundation, which gives grants for integrative health, authentic leadership, and vital organizations in our community. To continue to invest in Medtronic's future, we plan to buy additional Medtronic shares as soon as the deal closes.

The Star-Tribune Op-Ed columnist has the logic exactly backward. Medtronic's acquisition of Covidien is being done precisely to benefit all its stakeholders and to further the Medtronic mission. For me the litmus test is this: If I were still CEO of Medtronic, would I have done this deal? The answer is an emphatic "Yes." Omar Ishrak has demonstrated great courage with this step, making Medtronic an even more powerful voice in improving health care globally.

NY Times DealBook: Former Medtronic C.E.O. Defends Inversion Deal

From The New York Times DealBook, June 16, 2014

Bill George, a former chief executive of the medical device maker Medtronic, came out last month against Pfizer’s proposed inversion – a deal to acquire an overseas competitor and reincorporate abroad, lowering tax rates and freeing up overseas cash.

“Is the role of leading large pharmaceutical companies to discover lifesaving drugs or to make money for shareholders through financial engineering?” Mr. George wrote on DealBook. “Does anyone believe pharmaceutical companies can create long-term shareholder value by chasing lower tax venues and cutting research and development spending?”

But on Sunday, when it was his former employer doing the inversion, Mr. George was all in favor of the move.

Medtronic is acquiring Covidien for about $43 billion, and will reincorporate in Ireland as part of the deal, making it the latest big American company to invert. But the company claims that the move is not driven by financial engineering. The two companies make good strategic sense together, Medtronic argues, and its tax rate is already low. The big financial advantage, it said, will be the ability to access overseas cash more easily.

Mr. George, who owns a small amount of Medtronic stock but has not purchased any shares in the last five years, and who has not consulted for the company since he left 12 years ago, likes this logic. Despite his previous opposition to Pfizer’s inversion, he said Medtronic’s move to Ireland made sense.

“The only reason they’re doing the inversion is to free up the cash overseas,” Mr. George said in an interview. “That money today can’t be put to good use right now.”

Indeed, Medtronic said it planned to invest $10 billion in the United States over the next 10 years with some of that cash, a move apparently intended both to appease critics of inversions, and to emphasize the importance of the United States for the medical device industry.

As for taxes, Medtronic’s current rate of about 18 percent will only be lowered by one or two percentage points. That could still amount to big savings over time, but it does not represent the kind of enormous tax cut that other inversions would achieve.

Besides, Mr. George said that as chief executive, he worked to lower Medtronic’s tax rate. ”Medtronic has always tried to optimize its tax position, to minimize the taxes paid under the law,” he said, citing specific examples on his blog. “The taxes are simply too high in this country.”

Mr. George did not back down from his critique of Pfizer’s attempted inversion. ”Pfizer’s rationale was wrong,” he said. “They saw a chance to cut tax rates and cut people and R.&D.”

And while he stood beside his former employer, Mr. George also said lawmakers in Washington should pursue comprehensive tax reform, or at least institute a tax holiday.

“We’ve got to look at the reasons people are doing this, the fundamental, underlying issues,” Mr. George said. “We have to offer a holiday, period, whereby people could bring their cash back.”

CNBC: Medtronic’s $43B Covidien deal—and Irish tax move

From CNBC, June 16, 2014

Medtronic, the world's biggest medical devices maker by sales, will buy Ireland-based rival Covidien in a $42.9 billion agreement that could increase concerns about the rush of U.S. companies striking deals to cut their tax bills.

The deal, announced late Sunday, involves Medtronic paying $35.19 in cash and 0.956 of an ordinary share of Medtronic to Covidien shareholders - a premium of 29 percent to the Ireland-based company's closing stock price on Friday.

"This acquisition will allow Medtronic to reach more patients, in more ways and in more places," Medtronic Chairman and CEO Omar Ishrak said in a statement.

Minneapolis-based Medtronic will create two new, Irish-listed companies called New Medtronic and New Medtronic Sub through which it will channel the transaction. As well as saving on Medtronic's tax bill, the acquisition is expected to deliver around $850 million of annual pretax savings by the end of 2018.

"To finance the deal, they have some $13 billion to $14 billion in cash trapped overseas. They wanted to free that up to use that," former Medtronic Chairman and CEO Bill George told CNBC on Monday.

The U.S. company had also been linked to a potential bid for U.K.-listed Smith & Nephew.

Ireland's corporate tax rate of 12.5 percent is substantially lower than the U.K.'s 21 percent and the 35 percent in the U.S. Covidien itself is historically based mainly in Massachusetts, but moved its headquarters to Ireland for tax reasons in 2009.

Medtronic is the latest U.S. company to do a "tax inversion" — move its base overseas for tax purposes, so that overseas revenues will be taxed at a lower rate. This kind of move particularly suits pharmaceutical companies because they tend to be cash-rich and generate a significant amount of their revenues overseas.

George, who has been against inversions, said this one is different. "They are not doing it for tax savings. Pfizer is looking to cut its tax," he said, noting that the tax rate for Medtronic and Covidien is already below the U.K.'s 21 percent. "There is not tax-rate savings."

Pfizer had been pursuing U.K. drug-maker AstraZeneca before deciding to abandon its bid because of opposition. But that $116 billion offer raised eyebrows on Capitol Hill, spurring U.S. lawmakers to talk about how to close the tax inversion loophole.

Medtronic was careful to stress its commitments to research and development in the U.S. as part of the deal, and pledged to spend a further $10 billion in the country over the next decade.

"The medical technology industry is critical to the U.S. economy, and we will continue to invest and innovate and create well-paying jobs," Ishrak said.

Medtronic was advised by Perella Weinberg, while Covidien was advised by Goldman Sachs.

Seeking Alpha: Medtronic - Ultimate Success Of Covidien Acquisition Relies On Still Unknown Revenue Synergies

From Seeking Alpha, June 16, 2014

Summary

  • Medtronic is to acquire Covidien at a nearly 30% premium.
  • Tax inversion move to Ireland will create relatively few tax synergies, given the group's already low effective tax rate.
  • Revenue synergies determine the success of the deal as cost synergies of $850 million on a pre-tax basis hardly justify the nearly $10 billion premium offered for Covidien.

On Sunday Medtronic (MDT) announced that it will acquire Covidien PLC in an attempt to create a huge global medical device supplier.

Medtronic is paying a relatively steep premium to acquire Covidien which cannot be entirely rationalized by cost savings, as tax synergies will be limited despite the "inversion" move to Ireland.

The ultimate success of the deal depends on the size of revenue synergies, something which the company has not yet elaborated on.

The Deal Highlights

Medtronic announced that it has reached a definitive agreement to acquire Covidien PLC (COV) in a $42.9 billion deal.

Shareholders in Covidien will receive $35.19 in cash and 0.956 shares of Medtronic for each share they are currently holding. This values the company at $93.22 per share, a 29% premium compared to Friday's closing levels. Shareholders of Covidien will hold some 30% of the outstanding shares of Medtronic following the deal closure.

The board of directors of both companies have already approved the deal which is expected to close in the fourth quarter of this year, or in the first quarter of 2015.

Strategic Rationale

The new combination will even have a more comprehensive product portfolio, reach and opportunities to grow. The pro-forma business employs some 87,000 employees in some 150 countries.

Underlying the deal rationale are three fundamental reasons. Medtronic will gain many more innovative capabilities given the impressive portfolio of leading products in Covidien's pipeline.

The strong foreign exposure, even into emerging markets, brings a lot of global reach thanks to Covidien's operations. And finally are the revenue and cost synergies, allowing the new combination to package therapies and solutions throughout the healthcare system.

Financial Implications

The deal includes the famous "inversion" with regards to Medtronic's tax structure, which results in Medtronic becoming domiciled in Ireland for obvious tax reasons. The company's real operational headquarter remains in Minneapolis were Medtronic is currently employing 8,000 workers.

Medtronic estimates that the deal is accretive to cash earnings by 2016, the first full fiscal year after the anticipated closure of the deal. The transaction is seen accretive to GAAP earnings by 2018. By that year, the deal should result in $850 million in pre-tax cost synergies. Note that this estimate excludes any revenue synergies which are likely to be achieved.

Pro-Forma Calculations

For the fiscal year ending on April of 2014, Medtronic posted revenues of $17.0 billion, which up 2.5% on the year before. The company posted an 11.6% drop in earnings to $3.06 billion.

Medtronic held a strong balance sheet with $14.2 billion in cash and $11.9 billion in debt, resulting in a modest net cash position of $2.3 billion. The cash component of the deal calls for $15.9 billion in cash being transferred to Covidien's shareholders. This most likely requires still a significant bridge financing or credit line to be arranged despite the large cash balances.

Given that Covidien holds $1.2 billion in cash and $5.0 billion in debt, the pro-forma business will operate with roughly $17 billion in net debt. The company posted revenues of $10.2 billion for its most recent fiscal year, which is up 3.9% on the year before. Earnings fell by 10.8% to $1.70 billion.

The number of outstanding shares of Medtronic will increase from roughly 1.00 billion to 1.43 billion shares following closure of the deal based on these terms. Based on Friday's closing price, Medtronic's equity will be valued around $87 billion. However shares of Medtronic have risen to $66 in early trading on Monday, boosting the valuation to $94 billion.

The new pro-forma combination will have revenues of around $27 billion and post earnings of close to $4.8 billion. This values the new pro-forma equity at 3.4 times annual revenues and 19-20 times annual earnings. The company anticipates $850 million in pre-tax synergies, or roughly $743 million after tax. This increases earnings towards $5.5 billion, valuing the business at 17 times pro-forma earnings on the back of the anticipated synergies.

Note that potential tax savings might be minimal. Covidien paid an effective tax rate of 16.2% over its past fiscal year, while Medtronic had an effective tax rate of 17.3% last year. This is barely above the statutory tax rates of 12.5% for Irish-based companies.

Continued Commitment To The US

The move by Medtronic to "move" into Ireland might be politically sensitive, something which the company appears to realize as it attached a dedicated segment in the press release "demonstrating the commitment to the US."

Medtronic believes medical devices are among the US's most valuable exports and it stresses the commitment to R&D within the country.

The company will commit $10 billion in technology investments in the coming decade in areas like early stage venture capital, R&D and acquisitions in the US on top of its existing plans.

Takeaway For Investors

The $93.22 offer implies a roughly $9.5 billion dollar premium which Medtronic is offering for Covidien, little over 11 times anticipated annual pre-tax synergies. Given the run-up in Medtronic's shares in early trading, this premium has increased a bit more.

Note that the deal allows Medtronic to use its overseas cash without repatriating it, thereby avoiding billions in taxes to be paid if it wished to bring the cash home.

The new giant is also a more formidable competitor for Johnson & Johnson (JNJ) and to the healthcare system at large. As hospitals and medical centers are concentrating their purchases, being a more formidable supplier in the area is key in terms of product offerings as well as pricing power.

Medtronic will gain expertise beyond its current offerings like heart devices, spinal implants and insulin pumps to new areas like weight-loss surgery.

The rationale for the deal is expected to be driven by real cost synergies as anticipated tax synergies will be very limited despite the inversion move. The $850 million in pre-tax synergies are huge in absolute terms but don't forget that Medtronic is offering nearly a ten billion dollar premium to get its hands on Covidien. Shareholders in Covidien will furthermore hold nearly a third of the equity in Medtronic, being able to participate in the expected synergies.

The success of the deal will largely depend on anticipated revenue synergies which are not specified and hard to estimate. Note that Medtronic paid a $9.5 billion premium for Covidien based on Friday's prices and that its own shares trade some 9% higher in pre-market trading, thereby adding another $7.5 billion in equity value. As such an incremental $17 billion in value for Medtronic seems a bit steep based on the facts as outlined currently.

Therefore I am not convinced about the deal rationale for the moment, and will hold off making an investment on the back of the deal unless more gets announced regarding the size of potential revenue synergies.