Tax Inversion Laws Won't Tank This Deal

...Another one bites the dust

...Hey, I'm gonna get you too

...Another one bites the dust

If you remember the early 1980s like I do, chances are you remember the driving base line, electrifying sound, and scorching vocals of this smash hit performed by the British rock band, Queen.

An ode to the times, it came to symbolize any key event that doesn't go ahead as planned or an unanticipated outcome from which there is no potential recovery.

Like the long anticipated Pfizer/Allergan tie up.

That deal came to an unceremonious end earlier this week when the country's biggest drug company walked away from a $160 billion deal that would have relocated the company to Ireland as a means of lowering taxes.

President Obama didn't waste any time jumping on his stump, calling transactions like this one, "insidious" and saying they rob the American people of wealth.

For the life of me, I can't understand what part of this he doesn't understand... other than the whole part, as the old joke goes.

Today we're going to talk about why, and what this means for your money.

Believe me, it's NOT what you think, and I've got an investment that proves it!

Anti-Inversion Laws Are the Last Thing You Want as an Investor

tax inversionMost people are vaguely familiar with the concept of a tax inversion. If not, here's what you need to know.

Inversions are a special type of merger or acquisition wherein one company buys another specifically for the purpose of lowering its taxes. Usually, it's a foreign rival purchased in a lower-tax jurisdiction.

That was the case here. Pfizer Inc. (NYSE: PFE), which is based in New York, was buying Allergan Plc. (NYSE: AGN), which is based in Ireland. The intention was to "move" to Ireland, where it could have cut the company's tax rate in half, potentially saving it billions of dollars in the future.

It can't be any old company, though. The math has to be pretty finely tuned to really make an inversion like this one work.

The buyer's shareholders want to own 50% to 60% of the combined company when the transaction is consummated. Generally speaking, the benefits diminish as ownership climbs, which means owning 60% to 80% is still good, but not great. Above 80%, inversion transactions don't make sense.

The most effective transactions are ones that see a buyer target a rival company roughly two-thirds of its size. In this case, Pfizer's market cap stood at $200 billion, and Allergan's was roughly $120 billion, when the two agreed to play ball last year. Pfizer's shareholders would have owned an estimated 50% to 55% when the ink dried.

But the Treasury's new rules changed that by requiring the buyer strip out any purchases done in the immediate 36 months as a means of determining suitability.

Under the new rules, Pfizer's ownership would have seen ownership drop "into the high teens," according to The Wall Street Journal. So the board decided to bail and pay a termination fee of $400 million. That sounds like a lot, but as I mentioned on CNBC World following the news, the deal's not over by a long shot when it comes to a company that reported gross revenue of $35.7 billion last year.

Here's the thing.

What American politicians are really angry about is the loss of billions of dollars in tax revenue.

They cannot live within their means, so they've effectively decided to seize the wealth rather than let the money remain in the private sector by "escaping" the system.

[mmpazkzone name="in-story" network="9794" site="307044" id="137008" type="4"]

That's a load of hooey.

Every company - inverted or not - pays taxes on income earned in the United States. The only thing that happens differently in an inversion is that the company no longer pays taxes to the IRS on income earned in other nations. Money, I should add, that's fully subject to taxes in the country where it is earned.

Again, I don't do politics, nor am I qualified to sort out the moral implications of an inversion. So let's get that off the table right now.

My job is to tell you how this affects your money and to help you chart a profitable course.

Remember something we talk about a lot.

Every publicly traded company is motivated by profits and the investors who jump on board are motivated by their ability to generate future earnings in exchange for the risk they take as a shareholder.

Imagine being CEO of a company making $50 for every $100 in sales and having investors who are happy with a profit margin of 50%.

Now imagine learning that you could boost profits by 30% to $65 for every $100 in revenue by purchasing an overseas competitor and changing your corporate mailbox to Ireland. You'd still pay taxes on sales worldwide, but your existing shareholders would be thrilled because of the improved profitability.

What's more, your stock price would rise to reflect the additional money on the bottom line and, in the process, attract new investors. That, in turn, would give you better access to capital markets, better debt ratings, and still more strength to expand your operations in a never-ending cycle that makes your business stronger.

Contrary to what everybody thinks, most inversions are actually driven by growth and access to capital. As such, they create value.

Here's what you aren't hearing in the rush to stir up populist angst on both sides of the aisle - if inversions create value, then it stands to reason that trying to deter them will destroy value.

In Pfizer's case, having to walk away from the deal means that Pfizer will not be able to break itself up into smaller, nimbler, more profitable business units. So shareholders who would have received shares in each of the new ventures lose out.

Allergan loses out because the deal would have combined business units selling older, lower-cost drugs with new sales channels from new, high-cost, high-revenue products. Shareholders get hosed here, too.

Sadly, there's something far worse, though.

In its rush to demonize corporations acting in accordance with laws they passed in the first place, Washington has potentially hobbled stock markets for years to come and destroyed your retirement at the same time.

That's the really insidious part in all this.

The markets are a forward-looking animal - meaning stock prices are a function of investor expectations for future earnings, which are the sum total of everything from sales growth to product demand, expense management and - you guessed it - taxation.

When earnings are rising and profits are strong, prices head higher because investors expect growth ahead. When earnings are in decline and profits are falling, investors sell and move on to higher probability opportunities.

There's a reason why the Dow Jones Industrial Average grew by more than 22,000% during the last century. America was the best place to invest and offered investors the highest possible returns, stability and growth.

Anti-inversion laws may seem like a great idea, but the laws of money show very clearly that they're a precursor to the Law of Unintended Consequences.

If you're tempted to dismiss what I'm telling you today, I respect your opinion. In fact, I'm hopping mad that the system is so far out of whack and Middle America has been played the fool.

But that doesn't change the issue at hand one iota.

As Markets Teeter, Inversion Deals Offer Lifelines to Investors

The market is on eggshells at the moment because earnings season starts Monday and first-quarter earnings are expected to fall by 8.5% in the largest single percentage decline on a per-share basis since 2009.

That's a monster shift from the 0.8% analysts were predicting in January. Noted Jack Albin, who serves as chief investment officer at BMO Private Bank, "I can't justify prices where they are now."

Neither can I, considering that anti-inversion laws only stand to make this worse because they're another headwind that reduces profitability.

So now what?

Anti-inversion laws may feel like a moral imperative, but they're little more than political grandstanding at the end of the day. Money, like water, will always flow to where it's treated best.

Considering that an estimated 33% of the S&P 500's revenue comes from outside the United States, you can guess where it's going... inversion laws or not.

tax inversion

In keeping with a maxim we talk about a lot around here, it's a move related to, not one, but two Unstoppable Trends: Demographics and Scarcity/Allocation.

That means, like many other seemingly impossible situations we discuss, anti-inversion laws are actually a fantastic opportunity for the right companies.

My favorite way to play that is trash at the moment.

Literally.

Waste Connections Inc. (NYSE: WCN), which is based in Texas, is undertaking a "strategic merger" with Progressive Waste Solutions Ltd. (NYSE: BIN). According to a joint statement, anti-inversion rules will reduce expected cash flow by less than 3%. Ergo, there's still plenty of business rationale to charge ahead... not the least of which is more money.

And that's the key... plenty of business rationale.

WCN is about twice the size of BIN, with a market capitalization of $7.1 billion compared to BIN's $3.2 billion, so the merger satisfies the general rule of thumb I referenced earlier with regard to ownership and optimum size.

But the merger is savvy in another way that's near and dear to my investing heart.

By absorbing BIN's employees, assets, resources, and talent, WCN addresses what were its biggest weaknesses in the industry. Further, the company's anemic quarterly growth in revenue will see a huge shot in the arm from BIN, which managed to grow revenue by a whopping 141.50% year over year in 2015.

This kind of initiative reminds me of the genius driving another of our favorite recommendations, American Water Works Co. Inc. (NYSE: AWK), in the early 1990s when unit consolidation paved the way for a revenue jump from $573 million to $636 million in a single year. American Water Works, by the way, is one we're following in our sister publication and a company that's returned well into the triple digits since I recommended it to subscribers.

At the end of the day, if you really want to talk about something insidious, to borrow the president's term, try having a conversation with the millions of families who will be out of work when anti-inversion laws make it unprofitable for companies to keep them on the payroll.

I'll bet a "foreign" paycheck sounds pretty darn good.

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Editor's Note: Whether it's a failed corporate merger, drought in California, or even the 2016 presidential election, Keith is always looking beyond the headlines for investment opportunities to share with his subscribers. By using the six Unstoppable Trends, Keith finds profit opportunities in all kinds of markets, and has recommended more than a handful of companies that have surged within weeks of his readers hearing about them. In fact, he's already got an eye on his next venture. For a full and free report, including ticker symbol, sign up for Keith's free investment newsletter here.

About the Author

Keith is a seasoned market analyst and professional trader with more than 37 years of global experience. He is one of very few experts to correctly see both the dot.bomb crisis and the ongoing financial crisis coming ahead of time - and one of even fewer to help millions of investors around the world successfully navigate them both. Forbes hailed him as a "Market Visionary." He is a regular on FOX Business News and Yahoo! Finance, and his observations have been featured in Bloomberg, The Wall Street Journal, WIRED, and MarketWatch. Keith previously led The Money Map Report, Money Map's flagship newsletter, as Chief Investment Strategist, from 20007 to 2020. Keith holds a BS in management and finance from Skidmore College and an MS in international finance (with a focus on Japanese business science) from Chaminade University. He regularly travels the world in search of investment opportunities others don't yet see or understand.

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