An increase in mergers & acquisitions has been one of the leading investment themes so far this year. This week, 2014 became known for failed transactions, too. The week also brought potential trouble for tax inversions, which have been a growing part of the M&A boom.
Some $2.5 trillion of deals have been announced in 2014, according to Thomson Reuters. And $428 billion of deals have been withdrawn. Both numbers represent the briskest pace since 2007.
On Tuesday, $126 billion worth of proposed mergers were cancelled. First, 21st Century Fox dropped its $94 billion offer for Time Warner. Then Sprint abandoned its pursuit of T-Mobile in what would have been a $32 billion transaction.
Next, Walgreen Co. announced it will spend $15 billion to acquire the 55% of Switzerland-based pharmacy chain Alliance Boots that it doesn’t already own. But Walgreen won’t move its tax base overseas in a tax inversion deal.
In a tax inversion, a company buys a foreign enterprise and then changes its tax domicile to that of the acquired company in order to take advantage of lower tax rates. This has been an increasingly popular tactic for U.S. companies in recent years because our high corporate tax rate.
Walgreen’s announcement came after the Obama administration said it’s considering ways to block inversion deals without awaiting congressional action to change the tax laws.
Walgreen said that its option to buy the rest of Alliance Boots wouldn’t have qualified for inversion treatment. And the company was unable to find another structure it was confident could withstand IRS review.
Walgreen also noted that it was "mindful of the ongoing public reaction to a potential inversion … with a major portion of its revenues derived from government-funded reimbursement programs." By one estimate, Walgreen derives $17 billion a year in revenue from Medicar! e and Medicaid.
Three of the biggest withdrawn merger & acquisitions deals ever have occurred in just the last four months: AstraZeneca by Pfizer ($122 billion), Time Warner by Fox and Time Warner Cable by Charter Communications ($62 billion). All three were hostile takeover attempts, and Pfizer’s pursuit of Britain-based AstraZeneca would have been a tax inversion.
This week’s inversion developments have led to declines in the share prices of Shire PLC and Covidien. Both are foreign companies that have agreed to be bought by U.S. companies—AbbVie and Medtronic, respectively. Neither deal has closed yet, making each potentially vulnerable to any inversion rule changes. AstraZeneca shares also weakened because an inversion crackdown would make another Pfizer attempt less likely.
Some observers contend that this week’s broken deals and pressure on inversions signal a peak in the M&A wave. But history indicates that such tops occur with the completion of blockbuster deals and/or the inability to finance them. Neither is the case here.
What’s more, companies have huge amounts of cash available for acquisitions, and borrowing costs are extremely low. For example, the benchmark U.S. Treasury 10-year note yield yesterday touched a new 15-month low of 2.3 percent.
In addition, the bull market has pushed up share prices. While this boosts the cost of acquisitions, it also gives buyers a strong “currency” if they use their own shares to pay for some or all of the purchase. It’s often cheaper and always quicker to buy a business instead of launching a new one. And in a lackluster economy, acquisitions are a way to boost earnings growth through more revenues and/or increased efficiencies from economies of scale.
Improved job growth and other reports have led to projections of faster U.S. economic growth, such as a 3%-plus annual rate for the second half of this year. How long such an improvement could last is debatable. ! But at le! ast there’s little current evidence of a new recession or financial crisis on the horizon. If the economy indeed is improving, prudent acquisitions could provide a big benefit.
Either way, it’s been a positive sign that shares of companies announcing acquisitions generally have risen, in contrast to the typical historical pattern in which the buyer’s shares decline.
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