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Healthcare sector sees silver lining in U.S. tax inversion rules

NEW YORK (Reuters) – Investors and bankers have been lamenting the potential death of large cross-border healthcare mergers since the U.S. Treasury Department announced in late September that it would curtail the tax breaks from international deals designed to give U.S. companies a legal home in a low-tax country.

But now bankers and small-cap investors see a silver lining: Instead of quashing mergers and acquisitions altogether, the Treasury’s proposal on “tax inversions” may pull dealmaking onshore.

Companies, particularly in healthcare, that were looking to do big cross-border transactions now are refocusing on small and mid-cap U.S.-based deals, bankers say.

“Fundamental M&A should accelerate in the U.S., especially in respect of mid-cap biotechnology and specialty pharmaceutical companies,” said Michael Meyers, head of investment banking at Los Angeles-based T.R. Winston & Co.

Small, bolt-on acquisitions have traditionally been a staple of the healthcare industry as biotechnology and pharmaceutical companies try to add the most promising new drugs in development to their pipelines. But in 2010, the tax advantages Canada-based Valeant Pharmaceuticals International Inc and Palo Alto, California’s Jazz Pharmaceuticals obtained through inversion deals set off an arms race for similar benefits.

Now many bankers and investors expect companies that had to cancel their inversion deals, such as Abbvie Inc and Shire Plc, to go back to basics.

Pfizer Inc and other companies that have not done an inversion deal are under more pressure to grow through acquisitions to compete with those that have a lower tax rate, several investment bankers and investors told Reuters. During Pfizer’s third-quarter earnings call, executives said the company would assess deals on a case-by-case basis.

Likely targets, investors and bankers said, are companies with one or two promising new products, such as Avanir Pharmaceuticals Inc, which has an Alzheimer’s drug under patent; San Diego-based Neurocrine Biosciences Inc, which has partnered with Abbvie on an endometriosis treatment; and Puma Biotechnology Inc, which is developing a breast cancer drug.

All three companies are rumored to be the object of takeover deals in the next few months. None responded to requests for comment.

BACK TO FUNDAMENTALS

On Sept. 22, the U.S. Treasury Department announced a series of steps designed to make inversions more difficult and potentially less rewarding. [ID:nL2N0RN29G]

In a typical inversion, a large U.S. corporation buys a smaller foreign rival to adopt its nationality for tax purposes, even though core operations typically remain in the United States.

These deals have been particularly attractive in healthcare, where M&A is key to growth. By achieving a lower tax rate, these companies can come out as more attractive buyers for future transactions.

After Treasury’s announcement, at least two high-profile inversion deals were canceled. North Carolina-based Salix Pharmaceuticals called off its acquisition of Italy’s Cosmo Pharmaceuticals SpA, and U.S. drugmaker Abbvie backed out of its $55 billion deal to purchase Dublin-based Shire.

Abbvie investors said the company would be seeking acquisitions in the next six to 12 months to meet a deal-dependent earnings outlook. And Shire is looking for its own purchases, Chief Executive Officer Dr. Flemming Ornskov has said publicly

Shire’s focused business development is part of the company’s growth strategy, a spokeswoman said in an emailed statement. Abbvie did not return requests for comment.

Companies like Avanir, Neurocrine and Puma will not come cheap, but investors say drugmakers that missed out on inversion deals are under pressure to grow quickly and will seriously consider them for their earnings potential.

Furthermore, potential buyers may find tax relief in another quarter: The chances for lower corporate taxes in the United States have improved now that Republicans won control of the Senate in Tuesday’s election.