What Today's Covidien Acquisition Means for Medtronic (NYSE: MDT) Stock

Top stock news today: Covidien Plc. (NYSE: COV) stock jumped more than 28% this morning (Monday) following the announcement that medical-device maker Medtronic Inc. (NYSE: MDT) had acquired the company for $42.9 billion. MDT stock was up 4% in early trading, but has since pared those gains.

Medtronic officials announced that COV shareholders would be paid $93.22 per share through the deal. COV stock touched an all-time high $92.68 shortly thereafter.

MDT stock

Before today's transaction, these two firms were competitors in the healthcare space. Covidien develops and manufactures healthcare products designed for clinical and home use. Covidien sells a wide range of products including ventilators, feeding pumps, surgical equipment, and monitoring devices, among others.

Reportedly, Medtronic and Covidien wanted the deal mainly for tax purposes.

Covidien is headquartered in Ireland, where the main corporate tax rate is 12.5%. That compares to the 35% tax rate that U.S.-based companies, like Medtronic, face. That 35% is one of the highest corporate tax rates in the world.

While the U.S. corporate tax rate is considered high, Medtronic only paid a corporate tax rate of 18.4% in 2013. The company was able to avoid the 35% U.S. rate by keeping its international earnings outside of the United States. Medtronic was also given tax credits for research and development.

The move to incorporate in Ireland should help the firm lower its tax rate even further, and it will provide MDT more flexibility with its cash holdings.

According to a Wall Street Journal report, the Covidien acquisition will allow Medtronic to distribute approximately half of its free cash flow to shareholders, which the company had previously promised.

Medtronic has approximately $14 billion in cash, but because most of that money is held outside of the United States, Medtronic would have to pay heavy taxes to bring the cash stateside.

"To finance the deal, they have some $13 billion to $14 billion in cash trapped overseas," Medtronic's former Chairman and Chief Executive Officer Bill George told CNBC. "They wanted to free that up to use that."

Covidien, a spin-off of Tyco International Ltd. (NYSE: TYC) in 2007, was originally incorporated in Bermuda, where tax rates are also low. However, the company moved to Ireland in 2009 during a time when Bermuda-based companies were facing heavy scrutiny from U.S. lawmakers.

The combined company will house its main offices in Ireland, but Medtronic will maintain its "operational headquarters" in Minneapolis.

Tax-related acquisitions like today's Medtronic-Covidien deal have been growing in popularity as firms try to avoid the United States' corporate tax rates.

Last month, a $118 billion takeover bid from Pfizer Inc. (NYSE: PFE) was rejected by AstraZeneca Plc. (NYSE ADR: AZN). Based in the United Kingdom, AstraZeneca would have allowed Pfizer to reincorporate in the U.K., thus avoiding U.S. tax rates.

While one of the driving forces behind the Medtronic and Covidien acquisition was to lower corporate tax payments, it wasn't the only reason for the deal. And the other factors are the real benefits to shareholders...

What's Next for Medtronic (NYSE: MDT) Stock and Shareholders

The deal between Medtronic and Covidien still requires regulatory approval, but when the deal is finalized, Medtronic will have acquired more than just a new Irish address.

"Beyond the financial rationale, the company expands dramatically, and it puts them in a whole bunch of areas they never were in before. It makes sense," Jefferies analyst Raj Denhoy told Reuters.

The combined company is expected to have annual revenue near $27 billion, approximately 87,000 employees, and a presence in more than 150 countries.

That's a major boost in revenue for MDT, which reported making $17 billion in 2013.

According to Sanford C. Bernstein & Co. analyst Derrick Sung, the deal "would further enhance Medtronic's footprint, scale, and product offerings with its hospital customers."

Jonathan Gertler, the managing partner and chief executive of the Boston-based Back Bay Life Science Advisors, reiterated that point, telling the Boston Globe that the merger creates a "commercial powerhouse" in the medical-device market.

"Although there are blockbuster devices, a lot of the sales in that business are devices used in very specific therapeutic applications," Gertler said. "You unite two companies like this and you have remarkable therapeutic coverage in the hospital setting."

MDT stock has gained 11% in the last 12 months, but has slipped nearly 3% in the last 30 days. Acquiring a rival with a diverse product portfolio like Covidien boosts the company's product portfolio and allows the company to save billions in taxes annually.

Now that MDT can move its cash more easily thanks to its location change, shareholders can expect share repurchases or increased dividend payments when the deal is finalized.

Would you consider buying MDT stock following today's acquisition news? Share your thoughts on Twitter @moneymorning using #MDT.

Now: This metal problem could ignite China's smoldering crisis. Here's what investors need to know now...
Related Articles: