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Apple, Cash Kings Poised to Follow J&J's Tax-Dodging Mega Deal

How the Johnson & Johnson deal works:
  • JPMorgan and Goldman will borrow and buy 203.7 million Johnson & Johnson shares in the open market over the next year.
  • Johnson & Johnson uses foreign earnings held at its Irish subsidiary to buy $12.9 billion in its own shares from Goldman and JPMorgan.
  • Those shares, along with some cash, will then be handed over to Synthes, the acquired company, to fund its buyout, according to an 8-K filing J&J made with the Securities and Exchange Commission on June 12.
  • "Instead of a dilutive stock issuance followed by a share buyback program, the company has borrowed stock through an accelerated share repurchase agreement, which transforms the transaction into an accretive deal," said Jefferies analyst Jeffrey Holford, who upgraded J&J's shares to buy from hold, and boosted his price target for the company by nearly 6% to $72 in a June note to clients.

    With the risk that investors react negatively to any strategic acquisitions amid global economic worries, corporations looking to use M&A to buy new growth or products can use the J&J model as savvy means of deflecting concerns. And the clock is ticking.

    "Our tax experts further believe that the IRS is unlikely to respond with a new notice to close the tax loophole exposed by the JNJ/Synthes deal until the beginning of 2013, at the earliest," Novarro wrote.

    The deal has reignited a debate about taxation of foreign earnings at many of the largest companies in the U.S. If other corporations follow J&J's move, it may further provoke debate on whether the U.S. government should tax or offer a "holiday" to large corporations, who are sitting on over a trillion dollars in corporate cash, which is mostly held abroad to minimize U.S. tax bills.

    According to Moody's calculations, roughly $700 billion of the $1.24 trillion in corporate cash held by U.S. companies is sitting abroad, with overseas funds representing roughly 70% of the money in cash-rich sectors like technology.

    A return of foreign earnings from cash-rich international giants like J&J, Apple, Microsoft, Cisco (CSCO) and Google (GOOG) could be invested domestically during a period of weak economic growth (2%) and high unemployment (8.2%).

    Apple holds roughly 70% of its $100 billion cash stockpile abroad, according to Moody's, while tech giants Microsoft and Cisco hold nearly 90% of their cash overseas. With over $35 billion in cash, J&J held the sixth-most cash of any U.S. company, according to Moody's.

    Novarro notes that Apple would be likely to use its $74 billion-plus in foreign cash to make small deals and dividend payments, while the likes of Dell and EMC (EMC) could use their foreign cash to make larger acquisitions. Those with a high percentage of overall cash sitting abroad and operations headquartered in the U.S. are most likely to use the loophole, the analyst notes.
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