Medtronic's Acquisition Isn't Just About Lowering Its Tax Bill

NEW YORK (TheStreet) -- Medtronic (MDT), the world's second-biggest maker of medical devices, is making the largest acquisition in its history.

Medtronic is buying Irish competitor Covidien (COV) in a cash and stock deal for $42.9 billion. Medtronic is paying a 29% premium over Covidien's closing price on Friday.

Covidien's shares jumped over 19% on Monday to $86. On the other hand, Medtronic's shares have fallen by 2.9% to around $59.

More on Medtronic and Covidien:

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?

The deal is good news for Medtronic's shareholders because it allows the company to bring back billions in cash held in overseas markets while avoiding the U.S. corporate tax rate. But while Medtronic is paying a premium, analysts have pointed out that this is not an expensive purchase given the ongoing consolidation in the medical-products industry.

Medtronic is nearly twice as large as Covidien in market cap. Medtronic is known for its cardiovascular and orthopedic devices; Covidien makes feeding pumps, staplers and other surgical devices. Covidien was originally based in Bermuda but relocated to Ireland about five years ago after it spun out from its parent Tyco International (TYC).

The Irish corporate tax rate is 12.5%, one of the lowest in the developed world as opposed to U.S., where tax rate stands at 35%.

These kinds of deals are usually undertaken by companies that have significant cash reserves in the international markets. Bringing the cash home can result in a large tax bill. Some companies, such as Pfizer Inc (PFE) and Omnicom (OMC), have tried to relocate to other countries with substantially lower corporate tax rates by acquiring companies located in tax havens.

Medtronic has $14 billion cash, of which $13.5 billion is held in overseas markets. The deal will allow the company to fulfill its promise to distribute 50% of its free cash flows to shareholders while sidestepping the high taxes in the U.S. 

Medtronic has been using debt to reward its shareholders through dividends and buybacks.Consequently, the company will be able to reduce its reliance on debt. This will be a positive step as the company's debt-to-equity ratio has climbed to 61.35, which is more than three times as large as the industry's average.

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