) -- What if many of the worst performing companies from the 2008 crisis, most of which are either still losing money or struggling to make a profit, started buying up healthy, profitable companies?

Such a scenario is entirely plausible, according to Robert Willens, a corporate tax expert and head of Robert Willens LLC.

The purpose of such an odd-seeming transaction is straightforward enough: Tax avoidance. The losers lost so much money in recent years, they won't have to pay taxes for a very long time. The problem is that they don't make much money either, so they can't make full use of the losses.

If, however, they buy one or more profitable companies, their problem is solved. Why would a profitable company want to be acquired by a giant money loser? Why, to pay no taxes, of course!

Sound absurd? It may, but it is legal, and it was done recently by a

little-known company


Clarus Corp.


, a former financial software developer that acquired two makers of outdoor sporting equipment. Since the deal was announced on May 10, Clarus's stock has soared, even while the broader market has struggled.

>>>A Stock Up 30% Since Flash Crash

If this is such a great opportunity, why aren't companies talking about it?

One reason may be that talking about the opportunity is a good way to wreck it. To take advantage of the tax loophole, companies must argue, if challenged by the Internal Revenue Service, that tax avoidance is not the primary purpose of the deal.

"It's always good to sort of play down the tax opportunities," Willens says.

Other companies may not be aware of the opportunity to make use of the losses, Willens says.

That may be because people are used to thinking about struggling companies as potential takeover targets, not acquirers. But while buying a struggling company in order to make use of its losses is virtually impossible, "the tax law is much more liberal when it comes to an acquiring company using its losses against the profits of an acquired company," Willens says.

Other companies may be aware of the opportunity, but they may be cautious because doing an acquisition for tax-related reasons, while pretending to do it for a different reason, might result in bad publicity. John Delaney, Chairman of



argues his company won't need an acquisition to generate profits in short order in an

interview with TheStreet


Still, many companies have quietly taken steps to preserve the tax losses, which could be wiped out in the event of an ownership change, defined as a 5% shareholder increasing his stake by 50% or more. If an owner of 5% of one of these companies tries to up his stake by 50%, these "poison pill" provisions would trigger heavy dilution. Interestingly, though, companies that go through bankruptcy do not necessarily trigger the ownership change rule that would wipe out the tax credits.

Before I get to the list of companies who could make use of this strategy, a note on tax jargon: A net deferred tax asset counts as an asset on a company's balance sheet, while a valuation allowance is a liability. Both reflect a company's past losses. The difference is that a company's accountants force it to take a valuation allowance if they believe the company in question has a less than 50% chance of realizing enough earnings to make use of the loss.

Put differently, if a company has a valuation allowance, the acquisition of a profitable company can be especially beneficial because it can effectively turn a liability into an asset, leading to a rise in book value.

In an attempt to simplify this presentation, I included a catch-all category called "tax asset." Companies have different ways of describing the assets that can be used to offset taxes, and to avoid inaccuracies, I have tried as much as possible to replicate the language they use in their regulatory filings. Even though technically a valuation allowance is not an asset, it can become one via an acquisition, as Clarus has shown. To come up with the number for the category "tax-free earnings potential," I used the standard corporate tax rate of 35%.

Here, then, are eight companies with very large tax losses, and some thoughts about how likely they are to make use of them through acquisitions.


CIT Group

(CIT) - Get Report

, a New York City-based lender.

Tax asset:

$2.6 billion net operating loss carry forward, as of its latest 10-Q

Tax-free earnings potential:

$7.4 billion

Estimated profitability:

$906 million in 2011 (Sterne Agee)


CIT's ability to use the tax credits is somewhat constrained by the fact that it went through a Chapter 11 bankruptcy reorganization last year. CIT states in its latest quarterly filing that it is considering two options. One would allow it to use a maximum of about $230 million annually, meaning it would take more than 11 years to fully use its NOLs. The second option would allow CIT to use the $2.6 billion as quickly as it can earn enough money to do so.

However, if CIT chooses that option, the $2.6 billion figure will be reduced to account for deductions it made related to debt payments where the debt was converted to equity to enable the company to emerge from bankruptcy protection.

Bank regulators present one potential obstacle for CIT doing acquisitions. They forced CIT to "cease and desist" accepting deposits or lending out of its bank unit, and CIT is still trying to get approvals to start up again. Unless and until they get those approvals, acquiring another bank would seem to be out of the question. Acquiring a non-bank business, on the other hand, might run afoul of bank regulators, according to a top executive at a mid-sized bank that competes with CIT.


Washington Mutual


Tax asset:

Estimated at up to $2 billion

Tax-free earnings potential:

$5.7 billion

Estimated profitability:



When the holding company of Washington Mutual emerges from bankruptcy, it could have up to $2 billion left over to offset taxes on future profits, according to estimates by both Willens and Kevin Starke, an analyst at CRT Capital. WaMu may also be able to claim a worthless stock deduction of more than $20 billion, though there are a lot of vagaries around this issue.

One investor likely to own a stake in a restructured WaMu who declined to be identified says that while he is aware of the possibility of using WaMu to roll up other companies to make use of the NOL, it isn't at the top of his list of priorities. He isn't sure the potential reward from implementing such a strategy makes it worth the expense, he says, noting he is more focused on trying to squeeze all the money he can out of the bankruptcy case, which is still ongoing.



(F) - Get Report

, the only one of the "Big 3" U.S. automakers to avoid a bailout, is based in Dearborn, Mich.

Tax asset:

$6 billion in deferred tax assets in the U.S. ($17.5 billion globally)

Tax-free earnings potential:

$17 billion

Estimated profitability:

$4.5 billion in 2010 (

Thomson Reuters



Ford CEO Alan Mulally has become a corporate hero by getting Ford to focus on its core strengths, so no matter how profitable some wacky tax-driven acquisition might be, it is unclear whether Mulally could sell it to investors.

"I don't see Ford making any major acquisitions driven by this strategy," says Ephraim Levy, an equity analyst with Standard & Poor's. Levy points to the company's decision to end production of its Mercury line of vehicles.

"This way they focus more of their resources on Lincoln instead of

being divided between the two, so why would they go out and buy some other company?"

A company spokesman says Ford has looked at the idea of using acquisitions to make quicker use of its net operating losses, but rejected the idea. He declined to elaborate on the decision.


Synovus Financial

(SNV) - Get Report

, a Columbus, Ga.-based company that provides commercial and retail banking and investment services to companies operating in five states

Tax asset:

$548 million valuation allowance at end of 1Q

Tax free earnings potential:

$1.57 billion

Estimated profitability:

According to

Thomson Reuters

data, the company isn't expected to return to profitability until the third quarter of fiscal 2011.


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: Synovus stated in its latest 10-K that "the internal capital analysis used by Synovus management assumes that Synovus will be able to recover the majority of the recorded valuation allowance in 2010." It got off to a bad start toward that end in the first quarter, actually increasing valuation allowance by $105 million. Still, Credit Suisse analyst Craig Siegenthaler cited the likely reversal of the valuation allowance and a corresponding rise in book value in a June 16 upgrade of the stock.

Analysts do not appear to be expecting Synovus to do any acquisitions. In fact, analysts at both Credit Suisse and Sterne Agee have raised the possibility that Synovus might itself be acquired. If that were to happen, Synovus would almost certainly lose its ability to make use of the valuation allowance.

The company acknowledged this issue in its latest 10-K, also noting its ability to "utilize certain tax protect against an "ownership change." In this regard, it stands in contrast to

Ford Motor Co.

(F) - Get Report


CIT Group

(CIT) - Get Report



(C) - Get Report

, which have all adopted "poison pill" provisions to protect against an ownership change and preserve their tax assets.



(C) - Get Report

Tax asset:

$50.2 billion net deferred tax asset at end of 1Q

Tax-free earnings potential:

$143 billion

Estimated profitability:

$8 billion in 2010 (

Thomson Reuters



As the numbers above indicate, Citigroup has a huge tax credit, and unlike many other companies that lost tens of billions during the crisis, Citigroup has returned to profitability.

That means the bank should be able to avoid paying taxes for years, a point

I have made before

and which hedge fund superstar

Bill Ackman

has also cited in his bull case for the bank.

The advantage of Citigroup acquiring profitable companies is it would be able to make use of the tax credit much more quickly. However, whether the strategy is the right one or not, Citigroup is in slim-down mode, having hived off a substantial part of its business into a unit called Citi Holdings, where it houses assets and businesses it plans to either wind down or sell.

There is also the fact that a massive bailout recipient like Citigroup doing a major acquisition to avoid paying taxes would likely draw so much public scorn it would outweigh the economic advantages of such a deal -- assuming the deal even got done in the face of what would likely be fierce resistance from certain regulators and elected officials.


Hovnanian Enterprises

(HOV) - Get Report

is a Red Bank, N.J.-based homebuilder.

Tax asset:

$713.7 million valuation allowance at end of 1Q

Tax-free earnings potential:

$2 billion

Estimated profitability:

$109 million profit in 2010, but losses in 2011 and 2012 (

Thomson Reuters



Hovnanian is one of several homebuilders with a sizeable valuation allowance, though Hovnanian's is one of the largest relative to its size. Three homebuilding analysts I spoke to said they had heard no discussion of homebuilders mulling acquisitions to make use of their deferred tax assets.

Still the analysts were not dismissive of the idea: It was simply something they hadn't heard or thought of, and since they are not tax experts, they did not feel qualified to enter into a debate with Willens about whether such a deal would be feasible. Homebuilders, however, would seem to have a better chance than banks at executing such a strategy, as they face far looser regulations than banks, and are not subject to nearly so much public disdain.



(AIG) - Get Report

Tax asset:

$23.7 billion valuation allowance at end of 2009


earnings potential: $67.7 billion

Estimated profitability:

$1.2 billion in 2010 (one analyst surveyed by

Thomson Reuters



As probably the most heavily dependent company on U.S. government aid after

Fannie Mae

( FNM)and

Freddie Mac

( FRE) it is hard to imagine AIG getting away with buying up profitable companies to take advantage of this tax strategy. Such a move would provoke so huge an outcry it would be impossible for government officials to stand idly by while it happened.

The possibility cannot be ruled out, however, if AIG manages to pay back the government, and Fed Chairman Ben Bernanke claims it will. The fact that

AIG is already profitable

is a bit difficult to get one's head around, so seeing it go on an acquisition spree to make use of its massive tax credit -- well, stranger things have happened.


Ambac Financial Group

( ABK)

Tax asset:

$2.7 billion

Tax free earnings potential:

$7.7 billion

Estimated profitability:

N/A (lost $690 million in first quarter)


Analysts barely follow mortgage bond insurers Ambac and


(MBI) - Get Report

any more. The insurers have lost billions, as they face huge claims on securities they insured and are unable to write any new insurance due to their weak capital position and a huge drop in issuance of the type of bonds they previously insured.

"It's anyone's guess as to whether they'll make it or not. It's just kind of a black box right now," says Morningstar analyst Jim Ryan.

Still, MBIA and Ambac did not get bailed out, meaning they are not the political lightning rod that Citigroup or AIG are. The fact that no one pays any attention to them anymore means they might be able to pull off this unusual tax strategy in relative obscurity.


Written by Dan Freed in New York