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The marriage of Medtronic and
Covidien looks to be one of convenience. The $42.9 billion deal includes a
premium that exceeds the estimated cost savings. Stents and sutures are not an
obvious fit. And moving Medtronic’s headquarters from Minneapolis to Covidien’s
Dublin base will not obviously cut the American company’s tax bill. Freeing up
overseas cash is too shallow a reason to tie the knot.
There is reason to suspect a rush to the altar. Pfizer’s advance on AstraZeneca this year attracted the
attention of lawmakers in Washington to merger tax arbitrage. Congress is now kicking around
proposals to restrain so-called inversions, where a buyer finds a target
overseas to reduce what it owes Uncle Sam annually. Medtronic’s pledge
to invest an extra $10 billion in technology over the next decade as part of
the deal suggests some political concern.
Yet while buying Covidien will
relocate Medtronic to Ireland, there does not seem to be any immediate tax
savings. Over the last two years, the companies have paid on average almost the
same effective rate of about 18 percent.
What is more, although both
companies operate in the medical supplies industry, they do not necessarily
complement each other. Medtronic manufactures high-tech devices implanted in
people while its target makes basic surgical materials. These require different
mind-sets with regard to research, development and regulation.
Even so, there will be back-office,
supply-chain and other costs to hack, estimated at $850 million a year. Taxed
and capitalized, these would be worth about $7 billion today. Yet Medtronic’s
cash and stock offer
includes a premium of nearly $10 billion. Therefore, it is either overpaying or
expects to reap greater benefits elsewhere.
Medtronic alludes to some
tantalizing possibilities. It says the combination is expected to generate
significant free cash flow, “which it will be able to deploy with greater
strategic flexibility,” especially in the United States. One interpretation
could be that by moving overseas, Medtronic would be able to distribute more
cash to shareholders because it would no longer keep profit earned outside
America offshore, as many United States companies do, to avoid paying taxes.
That’s a nice perk, but a bit like
getting hitched for the party and the presents. Corporate betrothal, like the personal kind, ought to
have greater meaning.
Jeffrey Goldfarb is an assistant
editor and Robert Cyran is a columnist at Reuters Breakingviews. For more
independent commentary and analysis, visit breakingviews.com.
