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What Walgreen's tax-inversion move means for investors

By Cable Car Capital LLC

walgreens-wag

Several recent merger and acquisition (M&A) headlines in the pharmaceutical industry have a common underlying motivation. Consider the following: AbbVie's courtship of Shire, Pfizer's abortive pursuit of AstraZeneca, Salix Pharmaceutical's acquisition of Cosmo, and Mylan's purchase of Abbott Laboratories’ generics business.

This wave of proposed deals is partly due to potential tax savings through a mechanism known as a tax inversion. A tax inversion is a transaction through which a US company relocates its headquarters to a lower-tax jurisdiction by merging with a foreign company.

As the pharmaceutical industry consolidates in an effort to reduce costs after years of disappointing drug discovery efforts, many companies seek the added benefit of escaping high US corporate income taxes.

Tax inversions have become more frequent, with 11 transactions completed since 2012 and at least as many currently pending, mostly in the healthcare industry. The large number of deals has attracted political scrutiny, drawing calls from some members of Congress and the White House to curtail the practice.

The optics make for good political fodder: a company undergoing a tax inversion may retain its local operations entirely, but it begins paying taxes to a foreign government instead of the US. Under current law, a US company can redomicile to a foreign jurisdiction as long as foreign shareholders own at least 20% of the combined company. Congressional proposals to raise this threshold to 50% at the end of 2014 have only accelerated inversion attempts this year.

With this backdrop, several activist investors have been pressuring Walgreen Company (WAG) to reconsider the structure of its two-step acquisition of Alliance Boots (BOOT), Europe's largest drug wholesaler and a leading health-and-beauty franchise.

WAG acquired 45% of Alliance Boots in 2012, and it currently has the option to buy the remaining 55% during a six-month exercise window in early 2015. Although the current structure would not result in a tax inversion, there are several ways WAG could adjust the terms in order to reduce the company's tax rate close to the 21% rate in the United Kingdom, where most of Alliance Boots' operations are based. (Alliance Boots is incorporated in Switzerland for other tax reasons).

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