NEW LOW OBSERVER

Ireland and Tax Inversions

The year 2013 will go down as one of the most fascinating in stock market history.  In that year, while Congress was deliberating on Offshore Profit Shifting and using Apple (AAPL) as exhibit number-1, the pharmaceutical industry was entering a phase of industry consolidation and strategic positioning.

In the shifting of the landscape of the pharmaceutical business, the theme of alliances, acquisitions, and mergers fell along the lines of any connection with Ireland as a hub for tax reduction and avoidance in a strategy known as tax inversion.  One company that we followed was Warner Chilcott (WRCX) which was listed on the Nasdaq and was part of the Nasdaq 100 index.

Ultimately, Warner Chilcott (WRCX) would be acquired by Actavis (ACT) because Warner was domiciled in Ireland.  Actavis (ACT) would later change its name to Allergan (AGN) after Allergan merged with Actavis in March 2015.

Our May 22, 2013 thoughts on the deal between Warner Chilcott and Actavis was summarized as follows:

“It appears that paper gains due to mergers and acquisitions through the use of tax reductions and non-GAAP reporting is not a fundamental shift in Actavis’ ability to increase shareholder value.  Additionally, the +56% parabolic run-up in the price along with Edson Gould’s Speed Resistance Lines and Value Line’s fair value estimates suggest that the downside risks are significant.”

The mad scramble to acquire companies located in Ireland was like a tectonic shift in the industry.  Among those companies making deals and finding themselves in Ireland was Perrigo (PRGO).  Even though Perrigo’s operations are located in Allegan, Michigan the company is registered in Dublin, Ireland.  Perrigo pursued their tax inversion in 2013.

On December 21, 2018, it was reported by Reuters that:

“Ireland’s tax authorities have demanded that drugmaker Perrigo, formerly known as Elan, pay 1.64 billion euros ($1.9 billion) in taxes relating to the calendar year 2013, a U.S. securities filing showed.”

On news that Perrigo was being pursued for such a significant tax bill, the price of Perrigo’s stock declined –29.28% in a single day.

Perrigo is the Canary

Looking at the price of Perrigo Co. from the January 2013 low to the current price, we wonder if the tax inversion was worth it, on a long-term basis.

From where we stand, nothing that Perrigo did was necessary or worth it except to those in specific roles to directly benefit from such activities.  So far, the gains from the tax inversion have left shareholders at Perrigo worse off.

What did those inversion deals look like? See the diagram below:

Let’s look at this from a different perspective, could it be said that Perrigo has deservedly declined in price due to falling sales and earnings and not the pursuit of aggressive tax strategies?  The data (source: Value Line Investment Survey; October 5, 2018) from 2012 to December 21, 2018 has the following changes:

We suppose that the –63.16% decline in Perrigo shares since 2012 means that the stock is undervalued.  None of the fundamental metrics provided above indicate a decline that warrants or matches the drop that has occurred. However, the –81.82% decline in the stock price since 2015 indicates there is something fundamentally wrong.

Broader Market Implications

Returning to the Congressional hearings on tax inversion and offshore profit shifting in 2013, Apple (AAPL) was the headliner and primary punching bag.  However, in the earlier phase of examining the same topic, the 2012 hearings featured the actions of Hewlett-Packard and Microsoft.  From those hearings, the government contends (emphasis ours):

“We are going to examine the actions of two U.S. companies— Microsoft and Hewlett-Packard (HP)—as case studies of how U.S. multinational corporations, first, exploit the weaknesses in tax and accounting rules and lax enforcement; second, effectively bring those profits to the United States while avoiding taxes; and, third, artificially improve the appearance of their balance sheets.”

“The first step in shifting profits offshore takes place when a U.S. company games the transfer pricing process to sell or license valuable assets that it developed in the United States to its subsidiary in a low-tax jurisdiction for a price that is lower than fair market value (OFFSHORE PROFIT SHIFTING AND THE U.S. TAX CODE—PART 1 (MICROSOFT AND HEWLETT–PACKARD). Hearing Before the Permanent Subcommittee on Investigations of the Committee of Homeland Security and Governmental Affairs. United States Senate. One Hundred Twelfth Congress. Second Session. September 20, 2012. PDF here.).”

Is the use of the words “exploit,” “avoiding taxes,” “games,” and “artificially improve” an exaggerations or distortion of reality? The current plight of Perrigo (PRGO) should answer the question.  The next obvious question to ask is, if Apple (AAPL), Microsoft (MSFT) and Hewlett-Packard (HPQ) are also involved in similar aggressive tax avoidance strategies, will they be next to recognize similar penalties?

From what we can tell, Ireland would be shooting themselves in the foot to go up against the likes of Microsoft, Apple and the countless others.  However, the latest actions against Perrigo seem like an opening salvo in what will become a long running financial war.  In addition, these actions, coming after an extended period of economic growth appear to be sure signs a cyclical turn is coming.

A good scorecard for tracking tax inversion deals can be found at TheStreet.com where they list the top seven largest transactions as of July 2017.  The seven are:

• Allergan (AGN)
• Medtronics  (MDT)
• Liberty Global (LBTYA)
• Johnson Controls (JCI)
• Eaton Corp. (ETN)
• Restaurant Brands International (QSR)
• Perrigo Co. (PRGO)

What Happen to Actavis?

The diagram below shows what has happened to Actavis since our May 2013 posting.

Actavis continued on a shopping spree which has resulted in being publicly traded under the name Allergan (AGN).  We believe that the prime motivator for the deals that occurred since 2009 were in large part due to the immediately accretive “value” that was accomplished by continuing their shopping spree.  When the musical chairs slowed or stopped, the game started to unwind.  We believe this explains why Allergan (AGN) has seen its share value decrease starting in 2015 to the present.

Allergan has declined from the 2015 peak of $339.50 to the current level of $131.46, a drop of –61.27%.  If Allergan were to decline in a similar magnitude as Perrigo (-81.82%), the stock would achieve the $61.73 price point.  Even at such a level, it would be difficult claim that Allergan would be undervalued.  Also notice that Allergan is now priced at +1.10% above the May 22, 2013 level.  This cannot end well for current long-term shareholders.

Conclusion

We think that the actions against Perrigo (PRGO) will work like a virus and infect other Irish-based American drug companies and then bleed into other areas of the market.  The rate and spread of the virus is hoped to be rapid and broad so that we can get past the pain and move on.

Sources:

• OFFSHORE PROFIT SHIFTING AND THE U.S. TAX CODE—PART 1 (MICROSOFT AND HEWLETT–PACKARD). Hearing Before the Permanent Subcommittee on Investigations of the Committee of Homeland Security and Governmental Affairs. United States Senate. One Hundred Twelfth Congress. Second Session. September 20, 2012. PDF here.
• OFFSHORE PROFIT SHIFTING AND THE U.S. TAX CODE—PART 2 (APPLE INC.). Hearing Before the Permanent Subcommittee on Investigations of the Committee of Homeland Security and Governmental Affairs. United States Senate. One Hundred Thirteenth Congress. First Session. May 21, 2013. PDF here.
• Bowers, Simon. “Apple’s cash mountain, how it avoids taxes, and the Irish link”. The Irish Times. November 6, 2017, 17:55. link.
• Fahy, Graham. “Ireland demands $1.9 billion in back taxes from Perrigo.” Reuters. December 21, 2018. link.
• “Actavis buys Warner Chilcott, Upside Seems Limited." New Low Observer. May 22, 2013. link.
• Stewart, Emily. “As Treasury Moves to Bring Back Inversions, Here are 7 of the Biggest Recent Deals.” TheStreet.com. July 11, 2017, 3:12pm. link.