>>> Allergan/Pfizer have wiggle room to avoid tax inversion measures, advisors s

Merger Market

Allergan/Pfizer have wiggle room to avoid tax inversion measures, advisors say
* Premium would bring transaction below 60-80% threshold
* Substantial business test highlighted as difficult area
* Further measures on earnings stripping anticipated

Allergan (NYSE: AGN) and Pfizer (NYSE: PFE) could structure a deal that would comply with the US Treasury’s new anti-inversion notice, according to US-based tax specialists.

On 19 November, the Treasury Department issued new proposed rules to deter US companies from moving their headquarters to lower-tax jurisdictions.

The notice, along with comments from Treasury Secretary Jacob Lew, come as US-based Pfizer and Ireland-based Allergan hammer out the final details of their proposed merger. A number of other inversion deals are pending or expected.

The full rules for the restrictions had been eagerly awaited by dealmakers anxious to assess the impact on deals that are inflight.

Both an EU-based tax attorney and a US-based banker thought an obstacle to a deal between Pfizer and Allergan could be the Treasury’s “substantial business test” requiring that 25% of the post-merger business must be based in the home country of the foreign parent company.

This test was previously applied to determine that an inverting company would be considered a US company if 25% of employees, their compensation, the assets or the income is derived from the US. The latest rules require the merged entity to be a tax resident of the country of the foreign parent, essentially flipping these criteria.

“They couldn’t do this,” the EU-based tax inversion lawyer said, regarding Pfizer’s ability to overcome that test.

The newly issued rules note that Section 7874 of the Internal Revenue Code grants the Secretary “authority to prescribe the regulations as may be appropriate to determine whether a corporation is a surrogate foreign” entity.

But advisors pointed out the over-arching ownership requirement – that places restrictions on US inverting companies owning 60-80% of the merged entity – should mean that the Pfizer/Allergan transaction can be crafted in such a way as to escape the new tightened rules.

A third US-based tax attorney pointed out that Pfizer could structure a deal with a 30% premium to Allergan’s trading value, which would result in Pfizer owning 59% of the combined entity and thereby circumvent the Treasury’s substantial business test.

Alex Mostovoi, director of tax at Focus Financial Partners, thought there could be even more leeway to avoid the rules in terms of their impact on the Pfizer-Allergan deal.

As part of the combination with Allergan, Pfizer will acquire some valuable drugs, but could also repackage and sell some unwanted assets, Mostovoi said, a move that would fit with Pfizer's publicly stated consideration of a plan to split the company. “When you take this aspect of the transaction into account, it will provide a lot of flexibility in dealing with the new inversion requirements, including the 25% test.”

A healthcare banker agreed the new rules will not prevent a deal between Pfizer and Allergan.

“I think the deal goes through,” the banker said. The EU-based lawyer and the banker pointed out, however, that politicians do not want to see Pfizer’s tax revenues leave the country. The lawyer added that if Pfizer does manage to invert, competitors could follow suit.

Chilling inversions

Peter Schuur, a tax attorney at Debevoice & Plimpton, said the notice is not transformative. More than anything, it is a tightening up of Treasury’s previous notice from September 2014. “People are a little surprised the government didn’t go further,” he said.

The highlight of the 19 November notice was that a firm cannot buy a foreign company in an inversion and relocate that company to a third country, according to Bill Dantzler, a tax lawyer at White & Case.

Although the notice was aimed at chilling inversion activity, the new rulemaking announcement is “a stretch on [Treasury’s] authority,” Dantzler said.

In an interview, a Department of Treasury official responded that the department had closely reviewed and considered the new notice. “We think that our authority is clear to take these actions,” the official said.

The department is accepting comments on the 19 November notice, and there is currently no projected end-date to the comment period. “We don’t have a timeline on when the proposed regulations will come out, but it’s something we’re working on,” the official said.

Notably, Treasury still has not issued regulations to implement its September 2014 notice on inversions. Those regulations are expected “in the coming months,” the official added.

The third US-based tax attorney pointed out that based on the new rules for companies of a similar size, tax inversion deal-making is likely to continue. This attorney thought that new guidance on earnings stripping, the process where a company moves earnings from a high tax jurisdiction to a lower one often through subsidiary loans, would be more meaningful.

As Secretary Lew noted in his comments, “This is an important step, but it is not the end of our work. We continue to explore additional ways to address inversions -- including potential guidance on earnings stripping -- and we intend to take further action in the coming months.”

Treasury media affairs did not comment.

>>> Weekly Market Update: Markets Undeterred by Terrorist Attacks

Weekly Market Update: Markets Undeterred by Terrorist Attacks


The week began with investors largely looking right past headlines related to the disturbing Paris terror attacks. European indices made up all of their losses from last week and US equities returned to gains after last week's retreat. A second straight quarter of negative GDP put Japan back into technical recession, marking another setback for PM Abe's grand plans for reviving his country's economy. A chorus of commentary from US Fed officials book-ended the Oct FOMC minutes midweek, and largely cemented expectations US rates could very well begin going up next month, but that they will only be rising at a very tempered pace. In Europe, ECB President Draghi amped up expectations for more easing, while the PBoC cut short-term borrowing rates, to some extent fulfilling expectations that Beijing would do more to help the flagging Chinese economy. The US Dollar remained buoyed by the divergent central bank outlooks, resulting in a fresh 7-month low in the Euro. WTI crude blipped below $40 briefly but held that level into week's end, while copper saw another fresh 6-year low. For the week the DJIA gained 3.4%, the S&P rose 3.3%, and the Nasdaq rebounded 3.6%.

The minutes from the last FOMC meeting sent fresh signals that the Fed is more and more confident that it will raise interest rates at the December meeting as long as job growth and inflation trends don't take a turn for the worse. Most officials at the October meeting anticipated that December "could well be" the time for rate liftoff. "Most participants anticipated that, based on their assessment of the current economic situation and their outlook for economic activity, the labor market, and inflation, these conditions could well be met by the time of the next meeting," read the minutes. The US Treasury curve flattened following the minutes and stocks surged as markets appeared more comfortable that they can handle a gradual rise in rates.

Japan preliminary third quarter GDP was negative for a second consecutive quarter (-0.2% q/q), marking Japan's first technical recession since mid-2014 (the last one followed the increase in the consumption tax as part of Abe's Three Arrows reform). Corporate capex spending did the most damage, falling -1.3%, while the soft JPY boosted exports in the quarter to +2.6% from -4.3% prior and consumption was nearly flat at +0.5%. The negative print further boosted expectations for more BoJ easing or a supplemental fiscal budget to address the slump, although the BoJ maintained its stance at its policy meeting on Wednesday. The BoJ maintained its annual pace of monetary base expansion at ¥80T and also kept its overall economic assessment unchanged, while it slightly tinkered with its inflation outlook. USD/JPY marked an eight-week high after the GDP and BoJ developments on Wednesday, touching 123.65 before tightening up into week's end.

In a speech on Friday, ECB President Draghi made his case for more easing in December (the ECB Council meets on December 3rd). While the speech largely reiterated his past themes, Draghi added subtle changes that suggested even headline inflation moving towards target will not be enough. He said the ECB needs to be confident that inflation will not only converge to, but also stabilize around levels close to 2% over the medium term, adding inflation stabilization for the first time to ECB forward guidance. Analysts said his remarks suggest the ECB may sustain monetary stimulus even if oil prices push headline inflation above the 2% target. They also highlighted that German inflation hawk Weidmann took a different tack, called lower energy prices more of a stimulus than a deflation signal. The euro kept weakening and closed the week below 1.0650 for the first time since April.

A pair of US housing industry indicators stepped away from their recent highs. The NAHB index of homebuilder confidence declined slightly in November, to 62 from a revised reading of 65 in October. The October reading represented the highest level since late 2005, for a cycle high. Analysts were unsurprised, even as the reading missed expectations, calling the dip back to September levels a heathy correction that was in line with sales and mortgage applications readings. The annualized pace of housing starts fell 11% to a seven-month low in October, although it's worth remembering that October marked the seventh straight month of starts above 1 million units, the longest stretch since 2007.

Two more major US retailers got a thrashing this week despite reporting merely mediocre quarterly results. Target met expectations on the top and bottom lines, reported a good-not-great 1.9% gain in comps and slightly adjusted its FY guidance. Best Buy beat EPS expectations and boosted margins y/y. Investors frowned on initial FY16 guidance that called for nearly flat revenue and a modest decline in the operating income. BBY fell 8% at its worst after reporting, while TGT was off 6% at its worst. Both names recovered into week's end. Home Depot and Lowes saw strong gains on the week thanks to very good comp sales growth and more limited earnings and revenue outperformance.

Big name IPOs made a comeback this week with the initial stock offerings of Square and Match Group. Early in the week, reports said that the companies were being advised to cut their IPO prices to ensure early investors would be happy and indeed Match priced at the lower end of its $12-14/share initial pricing range while Square priced at $9/share, well below its $11-13/share initial range. With their modest pricing, both IPOs saw a big pop on their first day of trading, and each managed to trade above their respecting initial pricing range.

On Thursday, UnitedHeath Group cut its FY15 guidance and offered a slightly soft initial outlook for FY16. The CEO said the company had suspended marketing for Affordable Care Act exchanges and could exit the Obamacare individual health plan business altogether because it is losing money on the business. UNH's shares fell 6% in the session and the comments dragged down most of the sector. Analysts suggested bigger losses may be in the pipeline for other healthcare insurance names more exposed to flawed exchanges.

In M&A news, Starwood Hotels agreed to be acquired by Marriot for $12.2 billion, mostly in stock. Together, the companies will operate or franchise 5,500 hotels with a total of 1.1 million rooms, in around 100 countries. The already shaky $6.3 billion Staples/Office Depot merger was looking worse after the New York Post reported that the FTC might finally block the deal due to antitrust concerns. Shares of ODP were down 12% on the week. Railroad Norfolk Southern received an unsolicited offer from Canadian Pacific valued at $46.72/share in cash and 0.348 fixed share exchange ratio. Norfolk's board described the deal as low-premium and highly conditional but did not reject it out of hand, and CP's leadership indicated they may be willing to increase their offer. Recall that CP tried and failed to buy CSX last year.

The US Treasury implemented stiffer anti-tax inversion merger rules in an attempt to make overseas deals designed to avoid US taxes more difficult. The new rules restrict US firms from inflating the size of the new foreign corporate parent, and thereby avoid the current rule that requires the former owners of the US firm to own less than 80% of the newly combined entity. The move threw a monkey wrench in the ongoing merger talks between Pfizer and Allergan, but did not derail them. At the beginning of November, talks between the two companies were active, while this week reports suggested the deal could be priced as high as $150 billion, for the biggest drug industry deal in history. There were fears the deal might die under the knife of the new Treasury rules, although CNBC's Faber pointed out that the new rules apply to transactions where continuing ownership is in fact 60-80%, and under current talk Pfizer would own 59% of the combined entity with Allergan.

>>> US Close Dow+0.51% S&P+0.34% Nasdaq+0.62% Russell+0.72%

Closing Market Summary: Strong Week Ends on Higher Note

The stock market ended an upbeat week on a higher note with the bulk of today's action taking place during the opening hour. The S&P 500 gained 0.4%, ending the week higher by 3.3% while the Nasdaq Composite (+0.6%) outperformed, boosting its weekly gain to 3.6%.

Equity indices rocketed out of the gate, marking their best levels of the day about 45 minutes after the opening bell. The S&P 500 set a session high just above the 2,097 level and spent the remainder of the trading day in a slow retreat from that perch.

The consumer discretionary sector (+1.2%) displayed strength from the start while five other sectors also finished in the green. As for the discretionary space, the group extended its weekly gain to 4.5%, ending atop this week's leaderboard. Apparel names were largely responsible for the strength with Dow component Nike (NKE 132.65, +6.87) soaring 5.5% after announcing a new $12 billion share repurchase program and boosting its quarterly dividend by four cents to $0.32/share. In addition, the industry giant announced its stock will undergo a two-for-one split.

Staying in the discretionary sector, another apparel stock—Abercrombie & Fitch (ANF 24.37, +4.88)—soared 25.0% after beating earnings and revenue estimates while the broader SPDR S&P Retail ETF (XRT 44.16, +0.88) spiked 2.0%.

The strong showing from retailers overshadowed a 12.3% plunge in the shares of Chipotle Mexican Grill (CMG 536.19, -75.32), which unfolded after the Center for Disease Control published a report detailing new E. coli cases at CMG restaurants in six states.

Elsewhere among cyclical sectors, industrials (+0.6%) and technology (+0.9%) also settled ahead of the broader market while energy (-1.0%) and materials (-0.3%) could not stay out of the red. Interestingly, the energy sector finished at the bottom of the leaderboard even though crude oil overcame intraday weakness to end the pit session higher by 0.3% at $41.90/bbl.

Moving to the countercyclical side, consumer staples (-0.7%) and telecom services (-0.5%) retreated during the afternoon while utilities (+0.5%) and health care (+0.7%) settled in the green. The health care sector fared better than the biotech group as the iShares Nasdaq Biotechnology ETF (IBB 333.49, +0.07) settled flat.

Treasuries held modest gains through the bulk of the session but they dipped in the afternoon with the 10-yr yield ending higher by a basis point at 2.26%.

Today's participation was ahead of average with the final tally receiving a healthy boost thanks to options expiration. As a result, more than 950 million shares changed hands at the NYSE floor.

Investors did not receive any economic data today and Monday's economic news will be limited to the October Existing Home Sales report (consensus 5.50 million), which will be released at 10:00 ET.

  • Nasdaq Composite +7.8% YTD
  • S&P 500 +1.5% YTD
  • Dow Jones Industrial Average 0.0% YTD
  • Russell 2000 -2.4% YTD

>>> EMC/Dell tax worry overstated, attorneys say

EMC/Dell tax worry overstated, attorneys say
Dell's use of VMware (NYSE:VMW) tracking shares to help fund its purchase of EMC (NYSE:EMC) is not expected to trigger a tax liability, tax attorneys said.

As long as typical tax-sensitive features are used in the tracking stock, the tax liability is unlikely to be a real concern for the transaction, three tax attorneys told this news service.

Earlier this month online technology publication Re/code reported that Dell’s USD 67bn proposed acquisition of storage giant EMC could trigger a tax bill of USD 9bn. The Texas-based technology company has proposed to use cash and a VMware tracking stock to acquire the company.

The report, citing sources familiar with the matter, said the creation of the tracking stock in virtualization technology company VMware, of which EMC owns an 81% stake, could attract scrutiny by the Internal Revenue Service (IRS). The potential concern is the agency may deem the transaction taxable if the tracking stock disguises interest in the assets it will track.

Robert Willens, an independent tax expert, said that during the 35-year history of tracking stocks, the IRS has never attempted to argue that tracking stock is anything other than what it purports to be, stock of the issuing corporation.

A source familiar to the situation agreed, adding that it would be odd for the IRS to come up with new directives now.

“The correlation between tracking stock and the tracked asset in this case is quite tenuous,” Willens said.

Holders of VMware tracking stock, which is called Class V Common Stock, are subordinated to all creditors of Dell parent Denali Holding in claims, yet, no actual shareholders of VMware could be subordinated to the claims of Denali’s creditors, Willens explained, an argument that the tracking shares in VMware are more closely tied to Dell rather than VMware.

The first attorney and Willens said that the IRS is unlikely to rule on the tracking stock in this transaction, but there will be an opinion of the companies’ counsel, which will be forthcoming.

The Re/code story also said that Dell’s plan to create tracking shares in VMware, which it does not yet own, would be an effort to carefully manage tax laws since the transaction would not require a distribution of shares or a spin-off, two types of deals that are sometimes taxable.

Willens and two of the attorneys said they disagreed, noting that EMC and Dell structured the deal in a way where the link between the tracking stock and the tracked asset is more attenuated than normal, and the transaction is not “threading the needle,” as Re/code described it.

An example would be that Denali, the parent company of Dell, is not obligated to distribute to the Class V common stock holders any dividends it receives on the VMware stock, Willens said.

Class V common stock will be issued by Denali to track the performance of a portion of the group’s post-closing economic interest in the VMware business. Denali will issue approximately 223 million shares of the Class V stock at the closing of the transaction, according to SEC filings.

The first and second attorneys said that the companies were trying to structure the deal as a tax-free rollover transaction, which help align the interests with different parties and also bridge valuation and financing gaps.

The Re/code story also mentioned US Internal Revenue Code Section 355, and said that if Section 355 applies, the deal will not happen.

Section 355 regulates the distribution of stock and securities of a controlled corporation and has served as an essential tool for restructurings since it allows the movement of corporate entities to be tax-free.

Willens said Section 355 tolling can be easily dispensed if EMC is merged with and into Denali before spinning off VMware. This eliminates the “purchased” basis in the VMware stock and, in the process, eliminates the Section 355 issue.

The fact that Liberty Media (NASDAQ:LMCA) has been using tracking stock for decades in the face of the supposed risks involved shows the efficacy of tracking stock, added Willens and two attorneys.

Dell and EMC declined to comment. VMware was not immediately available for comment.