Corporate tax inversion revisited

Whether US companies are admitting it or not, as long as they place their priorities on satisfying their shareholders, they will continue to look in all corners either make more money or save more money.  This is the reality.  As a result, more and more companies have at least attempted to do this by trying to acquire foreign companies, followed by moving their headquarters to the foreign country, often a company in the UK, which happens to have a lower corporate tax rate.  This process is called corporate tax “inversion”.  Since our blog posting in late April of this year, the attempted inversion by Pfizer to buy AstraZeneca as been rejected, but other large US companies are attempting to do the same thing, such as AbbVie’s attempt to buy the Irish company Spire, and Walgreen’s attempt to buy the Swiss company Alliance Boots.

If too many companies are successful with inversion, it will likely exacerbate the public debt problem in the US, while spreading the tax burden to fewer players.  The only realistic solution is to lower the corporate tax rate ASAP, as the UK did a few years ago, before the problem gets worse.

US IRS continues to lose battle to effectively tax corporations

Many corporations (and all corporations set up under Subchapter S of Chapter 1 of the IRS code) are not taxed.  And for those that are taxed, many pay much lower than the maximum 40% tax rate.  In fact in 2011, the 10 most profitable companies paid an average tax of just 9%

US law disallows taxation of US company profits overseas.  In the 1990’s several US companies moved to tax havens such as Bermuda and the Cayman Islands, a maneuver called “self-inversion”, to reduce their tax burden.  Since 2004, tighter US regulations have done away with this practice.

Since 2004, US companies have looked for other ways to reduce the taxes that they pay, typically with the approval of shareholders.  One of the most popular ways is through a process of “inversion by merger”, whereby for example, a US corporation merges with a corporation which resides in a foreign country that has lower taxes than the US, followed by moving the newly created holding company to the foreign country.  This has been done several times over the past several years, which effectively moves dollars previously taxed and collected by the US to remain in the pockets of the foreign company and it’s shareholders.  The most recent example of an attempted “merger by inversion” in the news is the attempt by US-based drug company Pfizer to buy/merge with UK-based AstraZeneca.

Inversion activity is a symptom of problems in the international tax system that needs to be addressed.  At the very least, vague or nonspecific language in the current regulations such as requiring the company to perform “substantial business activities” in the foreign country, should be clarified in order to create a level playing field and to improve fairness to all countries in international tax reform.  However, the news is not all bad for the US IRS.  For example, there are still instances where it is advantageous for a US-based company to repatriate funds from overseas to the US, such as for reinvestment in the US.  A recent example is the US e-commerce company EBay, which recently said it will bring as much as $9 billion back into the US, which will create an additional $3 billion tax charge.

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Did Facebook overpay for WhatsApp?

Last week, Facebook announced that they were buying the instant messaging company WhatsApp for $19 billion.  Where does this valuation come from, and does it make sense for Facebook to buy WhatsApp?

One way to evaluate WhatsApp is based on the price for each and every user, which with 450 million users works out to $42 per WhatsApp user.  Therefore by this measure Facebook bought WhatsApp at a premium to what Facebook bought Instagram for last year (close to $30 per Instagram user), suggesting that Facebook believes it can ultimately make even more money with WhatsApp than it can with Instagram.

But is Facebook properly evaluating any of the companies it buys based on price per user?  Will WhatsApp ever earn $42, or even $30 for each and every user??  Maybe or maybe not, considering that just last week, the Japanese firm Rakuten bought a similar messaging app named Viber for only $9 per user, a greatly different valuation for this messaging firm which is centralized in Japan.  To be fair, there are unknowns such as whether the average Viber user is worth more or less than the average WhatsApp user, how well the respective companies can gain and retain users, the savviness, creativity, and ingenuity of company management to monetize it’s users, etc..

It appears that Facebook, while having the luxury or a large cash stash and getting brownie points forbeing  bold, is giving WhatsApp a lot of credit for future success.

Obamacare and the effect of it’s implementation on health care stocks

It is estimated that in 2014, as many as 30 million new people will be able to purchase private insurance on the federal or state regulated exchanges.  With a current population of about 317 million people living in the US, this represents a nearly 10% increase relative to the current population.  While cost savings will surely be wrung out of the system, we expect that a significant portion of this additional 10% will show up as additional earnings and profits by many of the companies represented by the health care industry, including hospitals, large pharmaceutical, and biotech companies.  And while the sickest segment of the population will continue to be heavily burdened with high medical costs, it is advisable especially for this segment to overweight their portfolios with health care stocks over the next 2 years so that the costs incurred can be at least partially offset by gains made by the health care companies.

Natural gas boom continues


Interest remains keen in natural gas production from shale reserves in the US.  In fact, as the map above shows (red areas), North America has more assessed basins of shale oil than any other region of the world, leading some to believe that future shale oil and gas production and exports will lead the US to economic prosperity.

As we reported in 2012,” lower natural gas prices are creating a structural economic advantage for the US, and is becoming a new competitive strength for U.S. manufacturers. Companies who purchase energy in Asia pay up to six times as much for natural gas as their counterparts in Texas and Louisiana.  Significantly, low U.S. natural gas prices should encourage an expansion in U.S. natural gas exports, especially once LNG terminals go online starting in 2014 and 2015.”

With the cost of natural gas remaining at a historically very low level, the process of exporting compressed natural gas  is becoming a reality.  For example, in May, 2013 the Obama administration approved a $10 billion facility in Freeport, Texas,  previously a second facility was approved at Sabine Pass in Louisiana, and  a third facility recently obtained conditional approval (Dominion Resources) at Cove Point, Maryland.  Exports are expected to begin in 2017 and 2015 respectively for the approved facilities.  In all, another 18 applications to export gas are being reviewed, indicating that this new business promises to be a very significant growth driver of the US economy.  Indicative of the magnitude of this industry, the approved facilities are each expected to export at least about a billion cubic feet of liquefied natural gas per day.