Considering Walgreen’s (WAG) and its plans to move to Switzerland, Pfizer’s (PFE) failed bid for UK-based AstraZeneca (AZN), and now Medtronic’s (MDT) acquisition of Ireland-based Covidien (COV), it’s very clear to us that many US-based companies want to escape the tax burden of the US.
We have no interest in generating a political stance for or against tax inversion (i.e. re-incorporating overseas to reduce taxes), but Dividend Growth portfolio holding Medtronic is the latest to pursue such a strategy. The medical technology firm announced June 15 that it will acquire Covidien in a cash-and-stock transaction valued at ~$93 per share. According to the terms of the transaction, each outstanding ordinary share of Covidien will be converted into the right to receive $35.19 in cash and 0.956 of an ordinary share of Medtronic. The ~$43 billion deal is based on Medtronic’s June 13 closing price of $60.70 per share.
Medtronic is paying above Covidien’s standalone value, but after factoring in the substantial cost synergies related to the transaction, estimated at ~$850 million on an annual pre-tax basis, the price is near Covidien’s adjusted valuation range. Using Medtronic’s ~10% discount/hurdle rate (weighted average cost of capital), we value the cost synergies on a go-forward basis at approximately $8.5 billion ($850 million divided by 0.099). Importantly, this estimate does not consider any potential revenue synergies resulting from the combined entity’s enhanced product portfolio and broader geographic reach–nor does it consider the substantial tax savings from the combined entity re-incorporating in Ireland (where Covidien’s current headquarters resides). The main corporate tax rate in Ireland is 12.5% compared to 35% in the US. On a cash earnings basis, the transaction is expected to be accretive in fiscal year 2016 (the first full fiscal year) and significantly accretive thereafter. We like the deal for shareholders of both parties.
Below, we’ve reproduced Medtronic’s strategic rationale from the press release:
• Therapy Innovation: With its expanded portfolio of innovative products and services, Medtronic will be a preeminent leader in delivering therapy and procedural innovations to address the major disease states impacting patients and healthcare costs around the world. Covidien has an impressive portfolio of industry- leading products that enhance Medtronic’s existing portfolio, offer greater breadth across clinical areas, and create exciting entry points into new therapies.
• Globalization: With a presence in more than 150 countries, the combined entity will be better able to serve global market needs. Medtronic and Covidien have combined revenues of $13 billion from outside the U.S., of which $3.7 billion comes from emerging markets. Covidien’s extensive capabilities in emerging market R&D and manufacturing, joined with Medtronic’s demonstrated clinical expertise across a much broader product offering, significantly increases the number of attractive solutions the new company will be able to offer to governments and major providers globally.
• Economic Value: Medtronic has adopted an intense focus on aligning with its customers to create more value in healthcare systems around the world – in various delivery and payment systems – by combining products, services and insights into solutions aimed at expanding access and reducing healthcare costs. With Covidien, Medtronic will be able to provide a broader array of complementary therapies and solutions that can be packaged to drive more value and efficiency in healthcare systems. Both companies’ deep relationships with healthcare system stakeholders will provide enormous ability to identify and create further value-based solutions.
Valuentum’s Take
As holders of Medtronic’s equity in the portfolio of the Dividend Growth Newsletter, we would have liked to see a better price paid for Covidien, but we still expect the deal to be value-creative for Medtronic shareholders. Covidien shareholders are getting a price greater than the fair value of Covidien’s assets on a standalone basis, and while no one was ever hurt taking profits, we expect continued value-creation from the combined entity through the latter part of this decade and beyond.
The day after the merger announcement Medtronic renewed its commitment to dividend growth shareholders, increasing its quarterly dividend to $0.305 per share (or $1.22 per share annualized). The increase marks the 37th consecutive year of increased dividend payments at Medtronic. We don’t expect to make any changes to the firm’s weighting in the Dividend Growth portfolio.
Please expect an updated dividend report on Medtronic soon.