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When companies flee U.S. tax system, investors often don't reap big returns
Establishing a tax domicile abroad to avoid U.S. taxes is a hot strategy in corporate America, but many companies that have done such "inversion" deals have failed to produce above-average returns for investors, a Reuters analysis has found.
Looking back three decades at 52 completed transactions, the review showed 19 of the companies have subsequently outperformed the Standard & Poor's 500 index, while 19 have underperformed. Another 10 have been bought by rivals, three have gone out of business and one has reincorporated back in the United States.
Among the poorest performers in the review were oilfield services and engineering firms, all from Texas. Among them was the first of these companies to invert, McDermott International Inc (MDR.N), which moved its tax home-base to Panama in 1983.
Drugmakers are dominating the latest wave of inversions and most of them have outperformed the benchmark index. So far in 2014, five U.S. pharmaceutical firms have agreed to redomicile to Ireland, Canada or the Netherlands. Deals that have not been completed were excluded from the review.
It is impossible to know how the companies might have fared in the market had they not inverted. Innumerable factors other than taxes influence a stock's performance, and no two of these deals are identical, complicating simple comparisons.
But the analysis makes one thing clear: inversions, on their own, despite largely providing the tax savings that companies seek, are no guarantee of superior returns for investors.
The deals basically involve a U.S. company initially forming or buying a foreign company. Then the U.S. company shifts its tax domicile out of the U.S. and into the foreign company's home country. The name "inversion" comes from the idea of turning the company upside down, making a smaller offshore unit the new head and the larger U.S. business the body.
Companies that do these deals typically promise shareholders will benefit. But aside from stock price underperformance by many, inversions can also impose substantial up-front tax costs. When a deal occurs, investors must recognize any taxable capital gains on their stockholdings. These costs are not taken into account in the study as they differ for each shareholder and don't apply in some cases.
"For some companies, these inversions are really smart business moves. For others, they're less smart ... You don't always know if it's going to work," said James Hines, professor of law and economics at the University of Michigan and one of a handful of academics who have closely studied these deals.
TAXES AND TEXAS
Corporations that invert say they are only seeking to pay the lowest tax rate they can get, noting this is what shareholders would expect them to do.
Inversion was pioneered as a strategy by oilfield companies that reincorporated chiefly in the Cayman Islands, Bermuda and Britain. Most have lagged the S&P500 since their inversions were completed: McDermott by 85 percent; Rowan Cos Plc (RDC.N) by 35 percent; Transocean Ltd (RIG.N) by 18 percent; among others.
These oilfield stocks also largely underperformed narrower Thomson Reuters and Dow Jones oil and gas equipment and services sector indexes, looking as far back as index data allows.
McDermott did not reply to questions sent to the company. Transocean did not respond to requests for comment.
A Rowan spokeswoman referred questions to the company web site. It said the company's 2012 UK redomiciling "was designed to enhance shareholder value," while putting Rowan closer to customers and North Sea operations and enabling it to stay competitive "with the effective tax rates of its global competitors, most of which are domiciled outside the U.S."
Beyond oilfield services, the inversion strategy has been used by a half-dozen U.S. insurance firms, with half of them outperforming and the rest either acquired or out of business.
White Mountains Insurance Group Ltd (WTM.N), managed from Hanover, New Hampshire, has outpaced the S&P500 by 248 percent since reorganizing in 1999 as a Bermuda corporation, for example. A spokesman for the company said it had no comment.
The analysis, using Reuters data and analytics, measured simple share price performance against the S&P 500 index using two benchmarks - the date when each company completed its inversion deal, and the date when each deal was announced.
With only four exceptions, the inverted companies that were still in business since doing their deals either uniformly underperformed or outperformed on both benchmarks.
For instance, U.S. engineering and construction group Foster Wheeler AG (FWLT.O) announced in November 2000 - when its stock was worth about $45 per share - that it was inverting to Bermuda. The deal, a statement said, was "expected to benefit Foster Wheeler and its stockholders for several reasons."
Since the announcement, the company's stock has lagged the S&P 500 by 50 percent; since the deal was concluded in May 2001, it has trailed the index by 83 percent. Foster Wheeler agreed in January 2014 to be acquired by UK rival Amec Plc (AMEC.L) for about $32.69 per share in Amec stock and cash at the time. The deal is expected to close in the fourth quarter.
Foster Wheeler spokesman Scott Lamb said the company dealt with weak markets, several problematic projects and a major debt restructuring after it inverted to Bermuda. It recovered and so did its stock price, but the 2008 economic downturn, he said, brought "an extended period of moderate demand and intense competitive pressure. These conditions have adversely affected the performance of all of the companies in this sector."
Also, in the past decade, he said, the company's revenue and employment base have largely shifted out of North America.
Concern is growing in Washington about inversions. President Barack Obama has criticized a "herd mentality" by companies seeking deals to escape U.S. corporate taxes.
Of the 52 inversions and similar redomiciling deals done since 1983, 22 have occurred since 2008, with 10 more being finalized and many more said to be in the works.
Following recent deals by major companies such as Medtronic Inc (MDT.N), bankers and analysts have said that another burst of deals is waiting to be unveiled in September.
Congressional action this year is unlikely with Republicans so far opposing Democrats' proposals, analysts said, though the Obama administration has been weighing executive actions.
For instance, the White House may announce tighter restrictions on federal government contracting with inverted companies, said Chris Krueger, an analyst at Guggenheim Securities in Washington in a research note last week.
Inversions have a firm legal basis. The government has been writing rules on them for 30 years. But they are complex and risky and some major proposed deals have recently unraveled.
On August 6, for example, after months of internal debate and public criticism from politicians, U.S. retailer Walgreen Co (WAG.N) said it would not reincorporate in Europe. It was considering using its purchase of Europe's Alliance Boots Holdings ABN.UL for such a maneuver.
Drugmaker Pfizer Inc (PFE.N) and advertising firm Omnicom Group Inc (OMC.N), U.S. leaders in their industries, have also walked away from planned inversions in recent months because they couldn't reach deals with their targets.
No two inversions are identical and they have changed shape along with evolving U.S. Internal Revenue Service (IRS) rules.
One appeal of inversions is putting foreign profits out of the IRS's reach. Another is "earnings stripping," in which a foreign parent lends to a U.S. unit, which deducts the interest to shrink its U.S. income for tax purposes, while the foreign parent books the interest at its home country's lower tax rate.
Inversion destinations have lower corporate tax rates than the United States. The top U.S. rate of 35 percent is among the world's highest. Add state and local taxes and, in much of the United States, the headline corporate rate is even higher.
Still, many U.S. companies pay far below that headline rate because of abundant loopholes that give businesses, especially big ones, a lower effective tax rate.
Inverting usually does not mean a U.S. company fully decamps from home. In most cases, it means opening a foreign office, but leaving core operations in the United States.
Inversions underwent a major change in 2004 when the IRS adopted a rule - Section 7874 of the tax code - that slapped new limits on the deals, making them harder to do.
Pre-7874 deals were sometimes known as "naked" or "self-help" inversions. One example was Helen of Troy Ltd (HELE.O), an El Paso, Texas consumer products group that sells hair dryers, kitchenware and other goods. In 1994, the company set up a Bermuda holding company and simply transferred its tax domicile into it. Since then, Helen of Troy has outperformed the S&P 500 by 219 percent. The company declined to comment.
Deals like this continued through 2002, involving groups as diverse as manufacturer Ingersoll Rand Plc (IR.N), which has outperformed the S&P500 by 103 percent since inverting in 2001, and underwear maker Fruit of the Loom. An Ingersoll Rand spokeswoman declined to comment.
Fruit of the Loom inverted to the Cayman Islands in 1998-1999. Three years later, it was bought out of bankruptcy by Berkshire Hathaway.
In 2004, Section 7874 was adopted in response to naked inversions. It set two tests for whether an inverted company is recognized as foreign or domestic by the U.S. government.
EATON AND COOPER
Since Section 7874, most inversions, though not all, have involved the acquisition of actual, operating foreign companies, with the costs, opportunities and challenges that can present.
For instance, Cleveland, Ohio's Eaton Corp Plc (ETN.N), a maker of power management products, in 2012 moved its tax domicile to low-tax Ireland by acquiring Cooper Industries, itself an inverted company that reincorporated from the United States to Bermuda in 2002 and then Dublin in 2009.
"The acquisition of Cooper was a strategic decision to add scale and breadth to our global electrical business ... The acquisition of Cooper was transformational for our business," said Eaton spokesman Scott Schroeder in emailed comments.
When the deal was announced, Eaton Chief Executive Sandy Cutler said it would shave about $160 million off Eaton's annual tax bill. He said business motivations, not tax reductions, were the key reasons for the transaction.
Eaton's effective tax rate in 2013 was only 0.6 percent, down from 2.5 percent in 2012 and from 12.9 percent in 2011, said Eaton's 2013 annual report to federal regulators.
"The lower effective tax rate for 2013, compared to 2012, was primarily attributable to the effects associated with the acquisition of Cooper, along with greater levels of income in lower tax jurisdictions and additional foreign tax credit utilization," Eaton said in the Securities and Exchange Commission filing.
Despite the tax savings, Eaton has underperformed the S&P 500 by 5 percent since completing the Cooper deal in November 2012. But, measuring from the day when the deal was announced in May 2012, Eaton's share price has outperformed the index by 9 percent, Reuters data showed.
The first U.S. drug company in the 52 to complete an inversion was biotechnology group Xoma Corp (XOMA.O), which shifted to Bermuda in 1998. Thirteen years later, the company returned its tax domicile to the United States, saying in a statement it wanted to reduce exposure to possibly adverse tax legislation and to come back to a more familiar legal system.
Xoma has posted losses since 2010 and, despite returning to California, has underperformed the S&P500 by 95 percent since it went to Bermuda. A spokeswoman said Xoma had no comment.
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