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New York Times DealBook - When Activist Investors Aim at Strong Companies

From New York Times DealBook, November 20, 2014

Activist investors have the “hot hand” these days. Their calls to break up companies have attracted growing attention, and their hedge funds continue to add new capital. Bill Ackman, for example, netted more than $2 billion on his investment in Allergan. He pressured its board to sell to Valeant, but profited even though the company was ultimately sold to Actavis. Carl Icahn challenged Apple’s cash hoard, while Mr. Ackman dislodged Robert McDonald as chief executive of Procter & Gamble. Chief executives are concerned that their company may be next.

Fueled by growing funds under management and emboldened by media coverage, the activists have recently shifted their focus to targeting America’s best companies. Why are activists pursuing those companies instead of moribund companies on the wrong track? The lofty strategic rhetoric of the investors notwithstanding, they are looking for quick gains. This may net handsome profits in the short-term, but it places the competitiveness of America’s great global companies at risk.

Let’s examine four situations among some of America’s best companies — Amgen, PepsiCo, DuPont, and Allergan — to see where activists have it wrong.

Amgen Under the leadership of Kevin Sharer and Bob Bradway, Amgen has been a stellar performer. In the past five years, its stock has increased 185 percent. Apparently dissatisfied with this performance, Mr. Loeb wants to break up the company. Break it up? It’s all one business. Centralized research and development fuels innovation that results in a steady array of breakthrough drugs. Amgen has exceptionally high net income margins of 27 percent and generates $6 billion a year in free cash flow, even after investing 22 percent of its revenues in research. Mr. Loeb’s idea of splitting older drugs from newer drugs would destroy one of America’s most productive innovators by taking away the cash it needs to develop new drugs, meet patient needs and fuel the company’s growth.

PepsiCo When she became chief executive in 2006, Indra Nooyi foresaw the need for healthy foods and beverages — trends currently sweeping the globe — and devised a long-term strategy to broaden PepsiCo’s portfolio. Pepsi’s performance the past three years has been exceptional. Its 52 percent stock price increase is double that of its archrival, Coca-Cola, which is trapped in a single-minded strategy focused on carbonated soft drinks and bottled water. Nevertheless, the activist investor Nelson Peltz is agitating to split PepsiCo in two, just as he did with Kraft. But both Kraft and its spin-out, Mondelez, are struggling.

DuPont Perhaps stung by his inability to influence PepsiCo, now Mr. Peltz is trying to break DuPont into three pieces. Has he not studied what the chief executive, Ellen Kullman, has been doing the past five years? When she took over in 2009, 200-year-old DuPont was a disjointed conglomerate without a clear strategy. Its stock had declined 62 percent since 2000. Ms. Kullman immediately went to work to reshape DuPont’s portfolio for the future, spinning off slow growth, low-margin businesses like performance chemicals and coatings. Now, DuPont is focused on three high-growth, high-margin businesses: agriculture and nutrition, biotechnology and advanced materials. Ms. Kullman is using DuPont’s vaunted central research labs to drive innovation in all three sectors. Her strategy is working. The company’s stock has increased 250 percent since she took the reins.

Allergan Bill Ackman successfully partnered with Valeant’s chief executive, Mike Pearson, to put Allergan in play and ultimately force its sale to Actavis, but why was that warranted in the first place? Since David Pyott joined Allergan in 1998 as chief executive, he created a more than 2,400 percent increase in Allergan’s stock. Allergan spends 17 percent of its revenues on research and development. These smart research investments have sustained the company’s high growth rate. Valeant’s strategy was to cut Allergan’s research spending to 3 percent of revenues, lower its taxes from 34 percent to 3 percent, and eliminate its executive team — which would ultimately make the company noncompetitive. For what purpose?

In contrast, an outside perspective can be a powerful catalyst for improvement at performing companies that are not performing well. Ralph Whitworth of Relational Investors helped save Home Depot by unseating its chief executive, Bob Nardelli, in favor of Frank Blake, leading to a decade of strong performance. Mr. Whitforth also turned around a dysfunctional board at Hewlett Packard, one that had previously fired three successive chief executives. Likewise, Jeff Ubben of the hedge fund Value Act Capital Management pressured the Microsoft board for change after 14 years of marginal leadership by Steve Ballmer. Since Satya Nadella took over last February, the tech giant’s stock has jumped 75 percent.

But in the case of strong companies with effective managements, activist attacks are enormously distracting. Executives focus on saving their companies and short-term financial moves, instead of winning global competitive battles, creating great products and building new businesses.

Trying to break up great companies only weakens one of America’s greatest competitive advantages: the leadership, strength, and adaptability of its global companies. The activists should keep their focus on the underperformers, and work to build the next set of great companies like Amgen, PepsiCo, DuPont and Allergan.

Bloomberg Video - Activists Going After America's Best

Why are activists going after America's best companies instead of trying to help the worst? Here are my thoughts on Bloomberg Market Makers: Video

CNBC: Google shacks up with Equinix for cloud boost

From CNBC, November 5, 2014

For the 100 billion Internet searches and more than 6 billion hours of YouTube videos streamed monthly, Google is building supersized data centers across the globe. But for certain functions, the company is better off using other people's property.

Equinix, which operates more than 100 data centers in 32 metro areas worldwide, is announcing on Wednesday that Google will be using its facilities to help clients in 15 markets, including New York, Atlanta, Frankfurt, Germany, and Hong Kong, access Google's business applications and cloud infrastructure.

The Google cloud needs all the help it can get. While the Mountain View, California-based company dominates the online advertising market, it's playing catch-up to Amazon Web Services in on-demand cloud computing as it also battles Microsoft's Azure technology.

The three companies are engaged in a brutal price war as they try to lure businesses looking to offload their computing and storage instead of handling it internally. Amazon and Microsoft are already Equinix customers. Now businesses can use any or all of them via Equinix.

"This completes our access to the big three cloud providers," said Equinix Chief Technology Officer Ihab Tarazi. Businesses can "get significantly higher bandwidth for very low economics and be able to completely leverage the cloud."

Google disclosed the deal with Equinix on Tuesday as one of several announcements tied to its cloud platform. The company also introduced Google Container Engine and a partnership with Docker to make it easier to create and manage applications across machines.

It's all part of Google's deeper dive into the world of business software, and it's not cheap. In the third quarter, Google spent $2.4 billion on capital expenditures, largely on data center construction and real estate costs.

"Everybody's moving their infrastructures to the cloud," Google Chief Financial Officer Patrick Pichette said on the earnings call last month. "It is an area where we have fundamentally great assets to contribute to this industry, both in terms of the flexibility, the cost structure, the technology. And that's why we're investing heavily in there."

Google owns and operates 12 data centers in the U.S., Europe and Asia, according to its website. Much of the software that Google as well as Amazon and Facebook have developed to bolster the speed and capacity of servers and databases is being replicated across the technology industry.

But that doesn't mean corporate America is ready to spin all of its most critical data up to the public cloud. Using Equinix, they can plug into the power of Google's infrastructure without relying on it entirely.

Equinix has more than 4,500 customers using its facilities. In April, the Redwood City, California-based company launched a service called Cloud Exchange to provide an added layer of security and enhanced connectivity for businesses that may have previously been reluctant to move applications to the cloud.

InsiderMonkey: Google Inc.'s Diversification Will Be Key to Future Success: Bill George

From InsiderMonkey, November 4, 2014

Google Inc. has been on a diversification drive in the recent past as focus shifts from the core search-business that it has come to be known of, over the years. Former Medtronic CEO, Bill George, during an interview on CNBC, argued that the company is doing the right thing moving into other areas of operations despite increased concerns.

CEO, Larry Page, believes the company is still in its teenage years with a lot to grasp, moving into adulthood in terms of innovating new products. Changes in the company have seen Sundar Pichai being given more responsibilities on Google Inc.’s core products.

“They are investing in a whole lot of things and I think they are doing all the right things. The question is can Larry keep all this things on track, it’s a bottoms-up innovation company, I think they are probably the best innovator in the world today, “said Mr. George.

George believes reorganizing is especially important for such a big company like Google Inc. as one of the ways of keeping employees motivated. While focusing on short term results George argues that companies resort to developing and evolving products but when focusing on the long-term success reorganization of the leadership structure is essential.

Google has in the recent past been diversifying its operations tapping into the healthcare space with iCare as well as showing intention of tapping into the auto industry with the driverless-car technology.

“Google Inc. is going in all directions; they have done a lot of deals in Google Glass getting into iCare and diabetes so they are going in a lot of directions. Can they keep all in track? We will see. I love the bottoms up innovation at Google, “said Mr. George.

The fact that Google has grown to become such a big company in terms of fields of operations is raising concerns as to whether it will be able to sustain its operations with the addition of more sectors. Diversifying into other sectors is key, according to Mr. George as it protects the company from being trapped in one field of operation.

New York Times DealBook: Jack Ma on Alibaba, Entrepreneurs and the Role of Handstands

From New York Times Dealbook, September 22, 2014 

I spoke with Alibaba’s founder, Jack Ma, at a private luncheon on Friday, just an hour after his company had gone public. Mr. Ma is unlike any Chinese leader I have ever met. He is emerging as the face of the new China: a free enterprise entrepreneur working within the confines of a rigid government.

Alibaba’s stock had just started trading on Friday, and it immediately jumped in value. It ended the day up 38 percent, at $93.89, giving the company a market value of $231 billion. The company set the record for the largest initial public offering in history. Yet Mr. Ma was humble, preferring to talk about building a great company that helps its customers, creates jobs and serves society. “They call me ‘Crazy Jack,’” he said. “I hope to stay crazy for the next 30 years.”

China’s large and growing economy has made it an increasing economic force over the last two decades, but it had not produced global companies. Chinese businesses focused domestically and mass-produced products for international companies. Mr. Ma is taking a different approach. Alibaba has initially concentrated on China’s enormous markets, but he understands the Internet is a worldwide phenomenon that knows no borders. He believes that Alibaba can compete internationally and across sectors, and intends to serve the American, European and emerging markets. But he said he won’t stop there. He has plans to disrupt China’s commercial banking and insurance sectors as well.

Asked about his success, Mr. Ma shares his life story. He was raised in humble origins in Hangzhou in the 1980s, just as China was opening up to the West. Growing up, he overcame one obstacle after another. He was rejected at virtually every school he applied to, even grade schools, because he didn’t test well in math.

He persevered. From age 12 to 20, he rode his bicycle for 40 minutes to a hotel where he could practice his English. “China was opening up, and a lot of foreign tourists went there,” he said. “I showed them around as a free guide. Those eight years deeply changed me. I became more globalized than most Chinese. What foreign visitors told us was different from what I learned from my teachers and books.”

As a young man, he applied for jobs at 30 companies and was rejected every time. At Kentucky Fried Chicken, 24 people applied, 23 got jobs; only Mr. Ma was rejected. So he became an English teacher at Hangzhou Electronics Technology College. In 1995, he visited America for the first time. “I got my dream from America,” he said. “When I visited Silicon Valley, I saw in the evening the road was full of cars, all the buildings with lights. That’s the passion. My role model is Forrest Gump.”

Returning to Hangzhou, he and Joe Tsai, now Alibaba’s executive vice chairman, founded the company in Mr. Ma’s modest apartment. They called the company Alibaba because it is “easy to spell, and people everywhere associate that with ‘Open, Sesame,’ the command Ali Baba used to open doors to hidden treasures in ‘One Thousand and One Nights.’”

Mr. Ma focused on applying his team’s ideas to help businesses and consumers find hidden treasures of their own. Yet he was unable to raise even $2 million from venture capitalists in America. Once again, Mr. Ma persevered. Eventually he raised $5 million through Goldman Sachs. Later, Masayoshi Son of Japan’s SoftBank invested $20 million, making it Alibaba’s largest shareholder. That stake is now worth about $75 billion. Today, the Alibaba companies serve 600 million customers in 240 countries.

With Friday’s I.P.O., Mr. Ma became China’s wealthiest citizen, worth more than $18 billion. Yet when he asked his wife several years ago whether it was more important to be wealthy or to have respect from business people, he said they agreed on respect. Mr. Ma talks about building the Alibaba ecosystem to help people, a philosophy that is baked into the DNA of the company. At the founding of the company, Mr. Ma issued generous stock option packages to early employees because he wanted to enrich the lives of all involved in his venture. He insisted that Alibaba’s six values — customer first, teamwork, embrace change, integrity, passion and commitment — be placed on the pillars of the New York Stock Exchange the day of the I.P.O.

For all his success, Mr. Ma has retained his authenticity. He recognizes that leadership is character, and he is focused on building his team. His role model is a well-oiled soccer team where 11 players work together for the success of the team. He would rather hire entrepreneurs than seasoned business executives, who are always looking over their shoulders, trying to please their bosses rather than their customers.

His own commitment to a cause larger than himself has propelled him onward. “My vision is to build an e-commerce ecosystem that allows consumers and businesses to do all aspects of business online. I want to create one million jobs, change China’s social and economic environment and make it the largest Internet market in the world.”

American tech leaders like Steven P. Jobs, Larry Page, and Mark Zuckerberg have emphasized technology and product above everything. Not Mr. Ma. “I’m not a tech guy,” he said. “I’m looking at technology with the eyes of my customers, normal people’s eyes.”

Mr. Ma said this was not just about making money. “I’m just a purist. I don’t spend 15 minutes thinking about making money,” he said. “What is important in my life is influencing many people as well as China’s development. When I am myself, I am relaxed and happy and have a good result.”

His lighthearted nature has helped create a unique culture and fun atmosphere at Alibaba where employees are given cans of Silly String, encouraged to do handstands to bolster their energy during breaks, and participate in an annual talent show where Mr. Ma sings pop songs. He practices tai chi and uses the nickname “Feng Qingyang,” a reference to a Chinese kung fu guru who trained an apprentice into a hero. Mr. Ma called martial arts “the most down-to-earth way of explaining Confucianism, Buddhism and Taoism,” adding, “They cherish brotherhood, morality, courage, emotion and conscience.”

He said he worried that China lost an entire generation when Mao Zedong phased out Confucianism and other forms of spirituality. But he said he hoped to restore that sense of values and purpose to the next generation. “It’s not policies that we need, but genuine people,” he said. Asked about corruption in China, he said, “I would rather shut down my company than pay a bribe.”

He listed three worries: continuing to create genuine value for his customers, working cooperatively with the government and building his team of global leaders. What will he do with his fortune? His big dream is to found a university for entrepreneurs that can create the new generation of Chinese entrepreneurs.

Jack Ma is a force of nature. He may become the role model for the new generation of global leaders, not only in China, but also throughout the world. “Our challenge,” he said, “is to help more people to make sustainable money that is not only good for themselves but also good for society. That’s the transformation we are aiming to make.”

HBR: The Conversation We Should Be Having About Corporate Taxes

From Harvard Business Review, August 22, 2014

The corporate inversion — when a U.S. company takes on the legal identity of foreign subsidiary, usually in order to reduce its taxes — has become about as controversial as corporate finance topics get. President Obama has called such transactions “unpatriotic.” Others have defended them as a way for American companies to stay competitive in the face of a uniquely intrusive tax code.

Harvard Business School’s Mihir Desai and Bill George both fall mostly in the second camp, but with some surprising twists that came out when I spoke with them recently. Desai is a professor at Harvard Business School and Harvard Law School who has done a lot of research on corporate taxes, and wrote the July-August 2012 HBR article “A Better Way to Tax U.S. Businesses.” George is a professor at HBS and the former CEO of Medtronic, which has been involved in one of this year’s highest-profile inversion transactions, a merger with Ireland-based Covidien.

Part of our conversation was recorded for an HBR Ideacast, which you can listen to below. What follows that is an edited, much-condensed transcript of both the Ideacast and the progressively wonkier discussion that ensued after the podcast was done.

Why have inversions become a big deal lately?

Mihir Desai: There was a wave in the early 2000s, and we shut them down with anti-inversion legislation. Now, instead of just being able to do it by yourself, the rules are such that you really have to have a foreign partner and there has to be a merger. As a consequence we now see these relatively high-profile mergers which facilitate the departure of U.S. companies. We have some of our largest and most innovative companies doing this.

So Bill, is the problem here — if there is a problem here — our corporate tax code or our corporate executives?

Bill George: The problem is definitely with the tax code. We have a dysfunctional tax code in the United States. We have among the highest tax rates anywhere in the world, and what’s happened is companies are paying taxes on foreign earnings that they generate overseas but they’re not bringing them back to the United States because they don’t want to pay at the U.S. corporate tax rate of 35%. You’ve got some $2 trillion of cash trapped overseas, so companies are looking for ways to use that cash effectively. It’s driven many U.S. companies to buy foreign companies, but in many cases they’d much rather deploy that cash in the United States.

One very interesting proposal came from Robert Reich, a liberal Democratic economist who recommended that the U.S. go to the system that almost all other industrial nations have of just taxing people where they earn the money. Personally I think that would solve the problem.

Mihir, you wrote an article for HBR a couple years ago on how to fix the U.S. corporate tax code, and I think this was one of the things you wanted to have happen. What were some of the other key changes?

Mihir Desai: This is the manifestation of two big problems. One is a high rate, and the second is this worldwide system, both of which are highly distinctive relative to the rest of the world. One of the things that’s happened recently is that leading countries like the UK and Japan, which used to look more like us, with relatively high rates and a worldwide system, have left. So now we’re really all alone — and that’s why these transactions are happening more.

A meaningful reform would combine two things. One, a considerably lower rate — and I think you need to get below 25% or 20% for it to be meaningful. And the second, as Bill mentioned, is a switch to a territorial regime. I actually am optimistic that we can get there; there’s a fair amount of consensus about that. The tricky part is where does the money come from to fund all of that, and there I think people divide up. My proposal has two particular sources of revenue-raising: One is that we have now large numbers of pass-through entities, and we have more business income in non-C-corporate form than we do in C-corporate form.

Like what kind of entities?

Mihir Desai: Those would be partnerships, those would be REITs, those would be subchapter S corporations — LLCs — and they have mushroomed wildly in the last 25-30 years. As a result the only people who pay the corporate tax are these large public multinationals, and that doesn’t make any sense. A small tax on those pass-through entities can help a lot. The second source of revenue is trying to change the fact that corporations report large profits to the capital markets and relatively small profits to tax authorities. If we make it more the case that you have to base your taxes on profit reports to capital markets, that can raise a fair amount of revenue as well.

Bill George: One issue I fear is how much money is going to be lost by the U.S. Treasury. When I’m talking to corporate CEOs, CFOs, and board members, I don’t see the major multinationals planning to bring that cash back to the United States. I was with the CFO of Apple the other day, and they’ve got $140 billion of cash trapped overseas. They aren’t planning to do an inversion, but on the other hand after tax they’re earning less than 1% on that money, compared to over 30% when they invest it in new products and R&D and innovation.

Mihir Desai: The amazing thing about Apple is they just decided to give back a lot of that cash in the form of dividends and share repurchases, but to fund it they’re not bringing the cash home from Ireland, they’re borrowing close to $40, $50 billion. Tim Cook in his testimony to the Senate committee said should I borrow money at 1% or should I pay 35% on my repatriated profit? The answer obviously is borrow at one.

One percent vs. 35%, that’s a really big difference. But at some level is there a conflict here, if you’re a CEO of a company — and you were one, Bill — between your obligation to your shareholders and others within your organization to minimize taxes, but then also your obligations as a citizen to not minimize them all the way to zero. What is the dividing line here? Is there one that we can identify?

Bill George: I’ve just spent many hours talking to Omar Ishrak, the CEO of Medtronic, who is involved in a major inversion, a $43 billion deal to purchase Covidien. The key question I asked him was, “Why are you doing this?” If he’s doing it for tax inversion, he’s got trouble. But he was very clear he was doing it to expand the Medtronic mission of helping patients — the strategy is a perfect fit, and it allows them to invest more money in innovation, ironically, because they can now use the $14 billion they have in cash trapped overseas to invest in the U.S.

You’ve been critical of some of the other inversions, such as the Pfizer one which isn’t going to go through.

Bill George: I was quite critical of Pfizer because I thought they were doing it for the wrong reasons. In fact Ian Read, the CEO, in his testimony to the British parliament, said he was doing it basically for two reasons, one for tax saving through the inversion and on the second to do all the savings he could by cutting people and combining. So I saw that in a very different context.

Back to the Medtronic example. Medtronic gets no tax savings. It already has an 18% tax rate and that’s about what they’re going to pay with Covidien. So there’s really no savings to them at the present time, but it does free up cash.

Mihir Desai: Bill’s example is interesting for two reasons. One is that we’re in such a crazy place that doing something that seems like it’s going to remove activity from the U.S. actually helps the U.S., because of all this capital that’s trapped overseas.

At the same time I do think your question puts your finger on something deep, which is there’s a growing distrust of corporations. When people see corporations doing this, they question their patriotism, as in fact the administration has. Corporations have to be more sensitive to this issue than I think they’ve been.

Bill George: There has been a lot of ill will over that and I think companies are going to have to step up and show their commitment to invest in the United States. Because this is the greatest place anywhere in the world to invest in innovation and R&D. As well as investing in social programs through their own philanthropy — I think many companies are stepping those up as well.

There is this argument from at least a minority of economists that the corporate tax is an abomination anyway, that we should just be taxing the shareholders — as we do, although right now we give them a lower tax rate — and not corporations. Do either of you think there’s any merit to that argument?

Mihir Desai: Well, yeah, I think there’s a fair amount of merit. And I don’t even know if it’s a minority. The corporate tax is a hard tax to like. It’s a hard tax to like because it’s a second layer of taxation and it’s entity-level taxation. So it’s always going to be dominated by a tax on individuals, because you’re giving another margin for distortion and another margin for evasion.

The reason why we might still like one, albeit it a low-rate one, is because without it you can run into some problems with individuals shielding and hiding their own income. Justin Fox Inc. can all of a sudden become a vehicle, if it’s got a zero rate, for shielding a lot of income. So we need a rate, and it’s probably positive.

One thing that’s really striking is how consistently, in polling, Americans of both parties, of all age groups, agree that the one group in this country that needs to pay more taxes than they do now is corporations.

Mihir Desai: It’s a puzzle. We know that corporations don’t per se pay taxes. That tax is going to be borne by shareholders, workers, or customers. Those are the only people who can actually end up paying the tax. So while people like to think about corporate tax reform as a sop to big business, the reality is that what we know about the corporate tax is it’s most likely borne by workers.

When you say it’s borne by the worker, you mean it comes out as lower wages?

Mihir Desai: Exactly right. It’s either the shareholders, the workers, or it’s going to be customers. And those other folks are pretty mobile. The workers aren’t.

Bill George: Just to illustrate that with an example. I serve on the board of Exxon, the world’s the second-largest market cap company. It’s very profitable. I don’t think that’s a bad thing. Exxon pays 45% tax on a global basis. Of course it affects dividend policy, it affects wage policy, it affects everything.

The real issue in our tax code is we’ve got a huge number of loopholes and a lot of favors given to various industries, and if we were to go to territorial tax system I think there’s a golden opportunity to get rid of a lot of these loopholes.

When you talk about loopholes, the reason why Apple and Google, they’re the most famous ones, have these massive piles of money overseas is because it’s income that they’ve paid almost no taxes on to any country at all. One of the questions is if you went to a territorial system and you didn’t fix these Double Irish Dutch tax sandwiches or whatever it is that they use to move income around, aren’t you just opening the door for a huge amount of abuse?

Mihir Desai: Let’s take Apple as one concrete example because the facts are relatively public. There’s $140 to $160 billion of offshore cash, $100 billion of it is in Ireland. Almost all of that $100 billion represents not profits earned in the U.S. but profits earned in Germany and Japan or China or wherever and then potentially shifted to Ireland. Do we care if Apple shifted money from Germany to Ireland? Frankly it’s not clear to me why the U.S. taxpayer cares about that. The German taxpayer should care about that, and the German taxpayer should be worried about it, and they should go after Apple if they want to. But why are we in the business of defending the German taxpayer?

Bill George: The one area the IRS and the Treasury would have to be very analytical and consistent on is transfer pricing. If companies are going to move technology ownership outside the United States, then you pay a substantial tax on that. That should be enforced. If you make products in the U.S., some of the profits should be captured in the U.S.

Let me give you specific example. Back in 1996, Medtronic made an arrangement to put a major defibrillator factory in Switzerland. The technology was all created in the United States, so what Medtronic did was sell that technology from Medtronic U.S. to Medtronic Switzerland, and pay a very substantial tax on that in the United States. After that it was governed by the Swiss tax system in terms of the profits made where manufactured.

With these companies where everything is intellectual property, and there aren’t factories moving from one country to another — Google is the really clear example of that — the tax authorities of the world seem to be struggling with how to do this correctly.

Mihir Desai: Absolutely, and one of the interesting things that’s on the horizon is the OECD has something called the Base Erosion and Profit Shifting initiative. They’re trying to come together and get at this idea of how does intellectual property get transferred and how do we value it. That’s a non-trivial problem.

The question politically is do we really think we’re going to get to a place where we have a multilateral organization, like the WTO, in taxes. I think the answer to that is, highly unlikely. That’s just a bridge too far for most people.

Bill George: You’re now getting into a much broader and more complex issue. With global corporations, they have to insure that they can be competitive around the world, and still be responsible to the national governments they serve. And there’s no such thing as global laws in many, many cases, including tax law. So you get a great deal of dysfunctionality, and I think this is why we need international bodies to help us work our way through these issues and sort them out.

Star Tribune: Upset stockholders confront Medtronic executives

From Star Tribune, August 22, 2014

Medtronic Inc. chief executive Omar Ishrak heard an earful from stockholders who got their first chance Thursday to directly question the company’s planned purchase of an Irish company.

Medtronic’s $43 billion deal to buy Covidien Inc. has drawn enormous media and political scrutiny as one of a growing number of U.S. companies purchasing firms in countries with lower tax rates, then relocating their legal headquarters abroad to take advantage of those rates.

For Medtronic’s shareholders, there’s another issue to the deal: Its structure creates a surprise taxable event for them — one that could cost thousands of dollars depending on how many shares they own.

Their complaints enlivened the company’s annual shareholder meeting, an event that is usually a formal discussion of numbers and new medical gadgetry.

“This is the least shareholder-friendly proposal that I have ever seen,” said Lee Binger, 79, of Maple Grove, drawing hearty applause from the crowd of 500 during the meeting’s Q&A period.

As Ishrak listened, Binger said he would have to sell much of his Medtronic stock to pay a tax on his capital gains — the difference between what he originally paid for the shares and their value at the time the Covidien deal closes. The tax is triggered because the deal effectively dissolves Fridley-based Medtronic Inc. and its stock. Shareholders would sell their stock and, in exchange, get shares in a new company called Medtronic PLC. Since Medtronic stock has performed well in recent years, people who bought at low prices decades ago face much greater sticker shock than institutional investors which buy and sell more frequently.

On Thursday, Medtronic shares closed at $64.10, not far from their all-time high of $65.50.

In response, Ishrak laid out the rationale for the deal in many of the same terms he has used since it was announced in June. He said Medtronic will reap long-term benefits through the acquisition, including the potential for greater profit that would raise the value of the investors’ new shares.

“There is a pain here, which I understand, and I don’t deny,” he said.

The Covidien deal is expected to close by early next year, but it could happen before the end of this year. The Federal Trade Commission is investigating the sale, and the Treasury Department is expected to propose rules soon to discourage such deals, known as “corporate inversions.”

Uncertainty about which tax year the deal would close also irritated attendees at the meeting. Others were upset that Medtronic is planning to cover an estimated $65 million in special excise taxes that apply to board members and officers of the company. Still other critics said they may not live long enough to see enough of a gain in the value of the new Ireland-domiciled company to make up for the immediate capital gains tax hit.

The meeting, held at a Medtronic office in Mounds View, kicked off with a presentation on how Medtronic products extend lives. But the question-and-answer session dealt mainly with the tax issues surrounding the Covidien deal.

At one point, Ishrak was heckled when he announced he would take only one more question, even though many hands in the crowd were still raised. He eventually relented and called on another half-dozen speakers.

Retired attorney Donald Zibell, 77, of Shoreview was skeptical that the deal would benefit him. He estimated that the stock price of the new Medtronic would have to rise by $17 a share in order to make up for the tax he will have to pay.

Medtronic executives suggested that stockholders could reduce their tax burdens by donating part of their holdings to charities or family trusts, rather than selling them. Former chief executive Bill George said that’s what he intends to do to defray the estimated $1.5 million in taxes he will face.

George said the inversion would trigger taxes that he and all investors would have eventually faced anyway.

“The stock has doubled since Omar came on board three years ago,” he said, referring to Ishrak. “I think this is the launchpad for the company to go to the next level.”

At the meeting, Ishrak also confronted criticism that the deal would allow Medtronic to avoid U.S. taxes. After the transaction is concluded, he said, the company will still pay the same tax rates on dollars earned in the United States that it does today.

One of the key motives of the deal, he said, is to allow Medtronic to bring $14 billion in foreign-held cash back into the United States without paying this country’s 35 percent corporate tax rate. Avoiding those taxes would allow the company to invest $10 billion in U.S. facilities that it could otherwise not afford under a traditional acquisition, Ishrak said, repeating an oft-heard pledge about the deal.

Twin Cities: Medtronic stock owners criticize deal, fearing tax hit

From, August 22, 2014

Frustrated Medtronic shareholders on Thursday questioned a proposed acquisition that would relocate the Fridley-based company's executive office to Ireland and sock some of them with possibly hefty capital gains tax bills.

"This is the least shareholder-friendly proposal I have ever seen," Arthur Binger, 79, of Maple Grove said, drawing applause from a crowd gathered for Medtronic's annual shareholder meeting in Mounds View.

In June, Medtronic announced a $42.9 billion acquisition of Dublin-based Covidien that is set to close late this year or in early 2015. During a lively question-and-answer session Thursday, chief executive officer Omar Ishrak argued the deal would create a medical technology giant that's better positioned for global growth.

At one point, Ishrak seemed frustrated by the questions and told the crowd he would take only one more. When the comment elicited groans, Ishrak lightened the mood and got some laughs by saying: "OK, two more."

He went on to take six more questions and ended the meeting on a sympathetic note.

"There is pain here, which I understand and I don't deny," Ishrak said. "All I can say is that, on balance, for the long-term value of the company, this is the right thing."

The Covidien acquisition would create a holding company called Medtronic PLC. It would be based in Ireland, although the operational headquarters would remain in Fridley.

With the new structure, Medtronic says it would be able to invest more money in the United States without triggering taxes -- particularly funds that Covidien currently generates from its overseas operations.

With the deal, Medtronic says it would expand its local workforce by 1,000 jobs in five years and invest $10 billion in 10 years in the United States.

But some shareholders Thursday questioned why Medtronic couldn't have found a way to realize the strategic goals without creating a capital gains tax hit for shareholders.

Judy Mandile, 61, of Plymouth said shareholders who must sell stock to cover the taxes could lose 20 percent to 35 percent of their net worth, as well as their income. That's because some long-term shareholders count on dividends from their Medtronic shares.

Patricia Hartlaub, 71, of New Brighton argued that the chance for long-term gains in the stock price is tough for many long-term shareholders to appreciate considering their age. She's owned her shares for more than 30 years.

Such investors might not be around long enough to see the promised growth, but they would face a tax hit in the short-term that could force some to sell about a third of their shares.

"It's a problem," Hartlaub said.

In a line that drew chuckles from an audience that included many senior citizens, she said: "I think if you look out at the group of people here, as well as long-term stock holders -- long term for us is short."

The concerns of individual shareholders are unlikely to scuttle the Covidien deal, said Brooks West, an analyst with Piper Jaffray Co. in Minneapolis.

Institutional investors such as pension and mutual fund managers hold the vast majority of Medtronic shares, West said, and those investors are more concerned about what the Covidien deal means for Medtronic's long-term growth prospects than the short-term tax hit.

"Institutional ownership is at about 86 percent," he said. "I'm still believing that the deal is going to go through."

But long-term individual investors are a relatively loud group in the Twin Cities because Medtronic has been a pillar in the local business community for decades.

The company was founded in a garage in northeast Minneapolis some 65 years ago, and currently employs about 8,000 in Minnesota.

One shareholder spoke on behalf of her 96-year-old father and said her family had owned Medtronic shares for more than 50 years.

"We have been the venture capitalists for Medtronic," the woman said while questioning Ishrak. "When you look at all the facts, everyone here is going to have to sell shares. And it's going to be millions and millions of dollars."

The Covidien proposal has placed Medtronic in the middle of a national debate over tax policy. The company is one of several this year that has proposed a so-called "inversion" deal to move its headquarters abroad in response to high corporate taxes in the United States. In an inversion, a U.S. firm acquires a foreign company and incorporates overseas to take advantage of a lower tax rate.

While some shareholders on Thursday questioned the structure of the Covidien deal, others voiced sympathy with Medtronic's tax challenges.

Longtime investor Jim Wychor, for example, asked Ishrak what shareholders could do to help overturn a tax on medical device manufacturers that's part of the federal Affordable Care Act.

After the meeting, former Medtronic chief executive officer Bill George defended inversion deal, even though he has criticized similar moves by other companies.

Medtronic has about $14 billion in cash overseas. If the company brought that money back to the United States to make investments, about $4 billion would be lost to taxes, George said in an interview.

"I think this will free up a whole investment period over the next 10 years," he said. "Tax inversions that are done for tax reasons only ultimately will fail, but ... the tax rate of Medtronic is not going to change significantly after this deal is done. It's the freeing up of the cash that's very significant."

Ishrak also tried to differentiate Medtronic's motives from other companies that are trying to move their headquarters outside of the United States.

"We're not going to pay any less tax in the U.S. after the transaction than before," he said.

Medtronic officials argue that the merger will create a company that's one of the world's largest suppliers of medical devices and products used by hospitals and clinics. The size should drive more innovation, company officials say, and products that help control rising health care costs.

"Over time, the up-side potential for the stock and the company is tremendous," Ishrak said. "It's a transformative move."

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.


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.”