steady pace of merger and acquisition activity, with several deals in excess of $1 billion announced. Level 3 Communications Inc. (LVLT) agreed to pay $7.3 billion to acquire TW Telecom Inc. (TWTC) ; SanDisk Corp. (SNDK) said it will spend $1.1 billion in cash to acquire Fision-io Inc. (FIO) ; and, in the biggest deal of the day, Medtronic (MDT) has agreed to pay almost $43 billion to buy small rival Covidien PLC (COV) .
In the deal, Medtronic, the second biggest medical device manufacturer after Johnson & Johnson (JNJ) , will pay $42.9 billion in cash and stock, valuing Covidien at $93.22 per share. The price tag represents a 29-percent premium over the closing price of COV shares on Friday. Upon completion of the transaction, each outstanding ordinary share of Covidien will be converted into the right to receive $35.19 in cash and 0.956 of an ordinary share of Medtronic.
The acquisition is structured as a so-called tax inversion, in which companies acquire others domiciled in foreign countries with lower tax rates, effectively reducing their overall taxes. Currently based in Minneapolis, Minnesota, Medtronic will be moving its headquarters to Dublin, Ireland, the current home of Covidien, although a large portion of Covidien’s operations are in Marshfield, Massachusetts. Ireland has a corporate tax rate of 12.5%, compared to the 35% tax rate in the U.S. that ranks amongst the highest in the world. Medtronic said it will maintain its operations in Minneapolis, where it employs more than 8,000 people.
The new company will have a presence in more than 150 countries and combined revenue of about $27 billion, $13 billion of which is generated from outside the U.S.
Companies don’t like to take about the tax inversion factor, generally focusing on synergies between the companies that drove the merger initiative, while remaining hush about taking money out of the U.S. The combined company is expected to result in at least $850 million in annual pre-tax savings by the end of fiscal 2018. Medtronics said that the tax arbitrage, which would amount to a few percent points tax savings by moving to Ireland, was not the driving force in the merger. Medtronic is currently only paying a tax rate of about 19%, but the rate could be moving upward as it negotiates a dispute with the IRS. Still, though, Medtronic spending part of its $14 billion in cash by re-domiciling to Ireland will result it significant tax savings for the company.
Medtronic said that the stronger merged company will be beneficial to the U.S., based upon reinvestment that will happen in the States. Above and beyond existing plans, Medtronic committed to $10 billion in technology investments over the next decade in areas such as early stage venture capital investments, acquisitions and R&D in the U.S.
"The medical technology industry is critical to the U.S. economy, and we will continue to invest and innovate and create well-paying jobs," said Omar Ishrak, Chairman and Chief Executive Officer of Medtronic, in a statement today.
The U.S. has made it harder for companies to avoid taxes by changing regulations that have taken away the lay-ups of companies simply re-domicile to low tax havens like the Cayman Islands, Switzerland or Bermuda or moving to countries where they are doing a significant portion of their business. While tax inversion schemes are not illegal at all and still happen, most today occur through large mergers, such as the Medtronic/Covidien deal.
There are ongoing discussions about the U.S. modifying its regulations again, either making it more onerous to employ tax inversion strategies or, conversely, possibly loosening some regulations that would inspire domestic companies to remain here and foreign companies to relocate to the U.S.
The tax savings by leaving the U.S. can be substantial. Consider that Applied Materials (AMAT) agreed last year to merge with Japanese chip maker giant Tokyo Electron in a deal valuing Tokyo Electron at $9.3 billion and reincorporate the new company in the Netherlands to help cut the tax bill. The five percent drop in tax rate from 22 percent to 17 percent will save the merged company about $100 million annually, based upon about $2 billion in profits. Now, extrapolate that information to get a breadth of the savings that Pfizer (PFE) would have received in its failed attempt to acquire U.K.-based AstraZeneca (AZN) for about $120 billion.
Outside the medical arena, another high profile deal was stuck and then called off recently between media giants US-based Omnicom (OMC) and France-based Publicis.
Companies like Medtronic are particularly incentivized to take a tax inversion approach because part of Obamacare included raising taxes for medical device manufacturers. In general, several companies in the medical device space have amalgamated, bolstering sales and trying to slash expenses in response to pressures of the healthcare reform laws. Two years ago Johnson & Johnson (JNJ) completed its $21.3 billion acquisition of Synthes Inc. Zimmer Holdings (ZMH) in April said it will buy Biomet Inc. in a cash-and-stock deal valued at $13.35 billion, including debt.
Shares of Medtronic are trading narrowly ahead Monday morning by a nickel per share at $60.75 and shares of Covidien have jumped ahead 22.2 percent to $88.04.