This article was originally published by TheStreet on June 16, 2014
By Sarfaraz A. Khan
NEW YORK (TheStreet) -- Medtronic (MDT_), the world's second-biggest maker of medical devices, is making the largest acquisition in its history.
Medtronic is buying Irish competitor Covidien (COV_) in a cash and stock deal for $42.9 billion. Medtronic is paying a 29% premium over Covidien's closing price on Friday.
Covidien's shares jumped over 19% on Monday to $86. On the other hand, Medtronic's shares have fallen by 2.9% to around $59.
The deal is good news for Medtronic's shareholders because it allows the company to bring back billions in cash held in overseas markets while avoiding the U.S. corporate tax rate. But while Medtronic is paying a premium, analysts have pointed out that this is not an expensive purchase given the ongoing consolidation in the medical-products industry.
Medtronic is nearly twice as large as Covidien in market cap. Medtronic is known for its cardiovascular and orthopedic devices; Covidien makes feeding pumps, staplers and other surgical devices. Covidien was originally based in Bermuda but relocated to Ireland about five years ago after it spun out from its parent Tyco International (TYC_).
The Irish corporate tax rate is 12.5%, one of the lowest in the developed world as opposed to U.S., where tax rate stands at 35%.
These kinds of deals are usually undertaken by companies that have significant cash reserves in the international markets. Bringing the cash home can result in a large tax bill. Some companies, such as Pfizer Inc (PFE_) and Omnicom (OMC_), have tried to relocate to other countries with substantially lower corporate tax rates by acquiring companies located in tax havens.
Medtronic has $14 billion cash, of which $13.5 billion is held in overseas markets. The deal will allow the company to fulfill its promise to distribute 50% of its free cash flows to shareholders while sidestepping the high taxes in the U.S.
Medtronic has been using debt to reward its shareholders through dividends and buybacks.Consequently, the company will be able to reduce its reliance on debt. This will be a positive step as the company's debt-to-equity ratio has climbed to 61.35, which is more than three times as large as the industry's average.
Medtronic has been using debt to reward its shareholders through dividends and buybacks.Consequently, the company will be able to reduce its reliance on debt. This will be a positive step as the company's debt-to-equity ratio has climbed to 61.35, which is more than three times as large as the industry's average.
Interestingly, according to Omar Ishrak, Medtronic's CEO, the company's relocation to Ireland is not going to cause any meaningful reduction in Medtronic's tax rate.
This is because Medtronic has been successfully maintaining a low corporate tax rate by keeping its foreign operations outside of the U.S. The company has also taken advantage of the research and development tax credits. As a result, in the previous fiscal year, the company's effective tax rate was 18.4%.
Following the acquisition, Medtronic will significantly grow in size. Medtronic had more than 46,000 employees and earned annual revenue of $17 billion in its previous fiscal year. The new company, however, will have nearly 87,000 employees and will earn combined revenue of $27 billion, of which nearly 48% will come from outside the U.S.
The bigger Medtronic will have a large portfolio of products for its hospital customers. The company will become a one-stop solution for its clients. Consequently, the new company might post better growth rates than Medtronic or Covidien. The former has struggled with revenue growth in the low-single digits while the latter's sales in 2013 were nearly the same as they were five years ago.
The bigger company, with operations in 150 countries, will be in a better position to compete with the industry leader Johnson & Johnson (JNJ_).
The deal will also result in annual pre-tax cost synergies of at least $850 million by 2018. Medtronic has not identified the revenue synergies the deal might create, albeit the details are still coming in.
At the time of publication, the author held no positions in any of the stocks mentioned.
This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.
