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Medtronic’s Play for Covidien Is No Solution for Silicon Valley

NEW YORK (TheStreet) -- Medtronic's (MDT - Get Report) $42.9 billion acquisition of Covidien (COV) and the company's proposed incorporation in Ireland will help Medtronic save billions of dollars in taxes that it would have faced if it decided to repatriate about $13 billion of foreign profit the company held overseas.

eBay's Tax Hit a Storm Cloud for Tech Sector?

While the blockbuster deal is a smart way for Medtronic to deal with its foreign cash -- especially given the company's decision to invest $10 billion of cash flow in the U.S. -- it will be a hard deal for tech sector giants like Google (GOOG), Apple (AAPL), Cisco (CSCO), Microsoft (MSFT), Amazon (AMZN), Facebook (FB) and Oracle (ORCL) to replicate. Unfortunately for Silicon Valley, it collectively sits on the biggest stash of undistributed foreign earnings of any sector.

The Medtronic deal for Covidien boils down to the following:

  • Over the years, Medtronic has earned billions of dollars of profit in its foreign subsidiaries, many of which are in jurisdictions with lower tax rates than the United States.
  • As a result, the company has generally kept its foreign earnings abroad instead of repatriating those profits to the U.S. where they would be taxed at a rate of about 35%.
  • That foreign stockpile has helped to keep Medtronic's overall tax rate below the rate that it is charged in the U.S. However, the move also creates liability.
  • Were Medtronic to repatriate those funds, it would eventually be taxed at the U.S. rate, meaning undistributed foreign profits present a risk to shareholders.

In buying Ireland-based Covidien, the former health care arm of Tyco (TYC), Medtronic has effectively dealt with any U.S. tax liability it might face from undistributed foreign earnings. Although Medtronic is proposing to take control of Covidien, the company is inverting its ownership for tax purposes and domiciling in Ireland. As a result, it is hard to see the company's foreign profits ever entering U.S. shores or the government's coffers.

"This way with the access to the cash flow from outside the United States deployed aggressively in the United States, we can go after many more investments than we could previously," Medtronic said on Monday.

In this regard, the deal promises to be a winner. Medtronic shareholders won't suffer a future repatriation charge. Meanwhile, the company now may feel free to invest heavily in the U.S. without the risk it runs afoul of its investors.

Not Helpful to Tech

Medtronic's deal isn't helpful to the aforementioned tech sector giants.

Apple, Microsoft, Cisco, Google and Oracle have a combined $307 billion of cash sitting overseas as undistributed foreign profits, or about 82% of their overall cash, according to a March 31 report from Moody's Investors Service.

With large U.S. revenue bases and market capitalizations of between $150 billion and $550 billion, it would be nearly impossible for tech sector giants to find a foreign partner to invert their tax bases and deal with undistributed foreign earnings in a single neat transaction.

Furthermore, the health care sector has pioneered the art of the inversion, meaning there are a number of firms like Covidien and Valeant Pharmaceuticals (VRX) that can either buy U.S.-based competitors or be used as the foundation of an inversion.

Shareholders, when presented with gigantic tax-savings in M&A, are likely to give a pass to deals that are only marginally strategic. In the tech sector, however, there are few foreign companies large enough to catch the interest of a Silicon Valley giant for tax purposes. Some deals, such as Microsoft's acquisition of Nokia's handset business and Apple's purchase of Beats Music that do achieve tax savings also come with big question marks.

eBay's Repatriation Charge

To make matters worse, eBay (EBAY) recently decided to repatriate $9 billion of undistributed foreign profits, creating a $3 billion charge against its earnings that will wipe out most of the e-commerce giant's 2014 net income. While that move was speculated to be the result of an imminent acquisition in the U.S., no deal has been announced.

The tech sector is in a tough position after building unprecedented cash stockpiles abroad. Unfortunately, Medtronic's acquisition of Covidien won't likely be seen as a cure-all for Silicon Valley's unspoken tax problem.

More on Medtronic and Covidien:

Cramer: A 'Who's Who' of Tax-Domicile Targets

Medtronic to Pay $43B for Ireland's Covidien

Medtronic and Covidien Deal Is Tax Strategy Guiding Healthcare M&A

Will Medtronic's Deal for Covidien Push Stryker to Smith & Nephew?

-- Written by Antoine Gara in New York

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