Medtronic's $43B deal brings more than tax savings


  • By Mark Basch
  • | 12:00 p.m. June 23, 2014
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The headlines last week surrounding Medtronic Inc.’s $42.9 billion merger agreement with Covidien plc were mostly about Medtronic’s “tax inversion” strategy.

However, there is more to the deal than just tax savings, and analysts say the merger of the two medical device companies is a good fit. At least eight analysts raised their ratings on Medtronic’s stock last week after the deal was announced.

In case you missed it, Minneapolis-based Medtronic agreed to pay $42.9 billion in cash and stock to buy Covidien, an international company that is headquartered in Dublin, Ireland.

After the merger, Medtronic intends to keep its “operational headquarters” in Minneapolis but will officially move its corporate headquarters to Ireland and rename itself Medtronic plc.

By doing that, Medtronic will pay corporate taxes at the lower Irish tax rate than it currently pays as a U.S. company. It also frees up billions of dollars in cash that Medtronic has from overseas operations that the company was reluctant to use because of the higher U.S. tax implications, analysts said.

This strategy of re-incorporating a business in a lower tax-rate country is commonly known as a corporate inversion, or a tax inversion.

The tax savings are one positive of the deal, but analysts said there are others.

“The rationale for the Covidien deal is strategically and financially sound, and its long-term benefits may be underappreciated,” Morgan Stanley analyst David Lewis said in a research note.

He raised his rating on the stock from “equal weight” to “overweight.”

William Blair & Co. analysts Ben Andrew and Margaret Kaczor, who raised their rating from “market perform” to “outperform,” said the merger will allow Medtronic to offer customers a greater range of products.

“Medtronic’s CEO Omar Ishrak has spoken extensively about the need to provide hospitals with cost-effective clinical solutions for their patients rather than merely selling them the latest and greatest (and often more expensive) pacemaker, coronary stent, or spinal implant,” Andrew and Kaczor said in their research note.

“This service orientation, providing a turn-key solution to a customer, is a dramatic shift from its historical product focus,” they said.

Analysts said there is not a lot of overlap in product offerings from the two companies.

“In our view, the combination of Medtronic and Covidien would have minimal direct strategic overlap in terms of products, and therefore FTC concerns could be low, but there are a number of adjacencies that could add to the strength of Medtronic businesses,” Barclays Capital analyst Matthew Taylor said in his report as he raised his rating from “equal weight” to “overweight.”

The overlap issue is significant for this area because Jacksonville is an important operational center for Medtronic.

Medtronic came to Jacksonville in 1999 by acquiring Xomed Surgical Products Inc., which made surgical instruments for ear, nose and throat physicians.

The company expanded its Jacksonville facilities in 2012 and made it the headquarters for its entire surgical technologies division. Medtronic now employs about 700 people in Jacksonville.

Medtronic spokesman Fernando Vivanco said last week that it is too early to say if the Covidien merger will impact the Jacksonville operations, but he said the company is not looking to slim down.

“This is really about growing the business and not about cutting at this point,” he said.

Vivanco echoed analysts’ views on the two companies’ operations. “They’re quite complementary. There’s not a lot of overlap,” he said.

Medtronic said, overall, it will have 87,000 employees in more than 150 countries after the merger.

Surgical technologies are also a big business for Covidien, in fact bigger than Medtronic, according to the William Blair analysts. Medtronic’s surgical technologies division reported revenue of $1.6 billion in the fiscal year ended April 25, while Covidien had $4.8 billion in revenue in that area in its last fiscal year, they said.

However, the two companies focus on different markets for those products, they said.

Andrew and Kaczor are upbeat about Medtronic’s prospects after the merger.

“With minimal product overlap allowing for a faster revenue growth rate, significant emerging markets exposure, potential operating synergies, and a more efficient tax structure, we believe such an acquisition makes tremendous sense from both strategic and financial perspectives,” they said.

Sunshine State policies transferred after liquidation

A month ago, Jacksonville-based Sunshine State Insurance Co. seemed to find a solution to its financial problems by agreeing to a merger with United Insurance Holdings Corp.

However, that deal fell apart and Sunshine State was placed into receivership by insurance industry regulators. Last week, Sunshine State’s 35,000 property insurance policies were transferred to a subsidiary of Clearwater-based Heritage Insurance Holdings Inc.

Sunshine State was ordered by the Florida Office of Insurance Regulation in March to raise capital. In May, St. Petersburg-based United Insurance announced the agreement to buy Sunshine State and retain its management and employees.

However, publicly traded United Insurance called off the deal two weeks later, saying it was in the best interests of its shareholders.

Without a merger partner, Sunshine State was placed into receivership June 3 and was ordered to be liquidated.

Heritage Insurance said it outbid nine other companies to acquire the 35,000 Sunshine State policies with $60 million in premiums.

However, Heritage Insurance is not taking in the Sunshine State employees with the deal.

A Heritage Insurance spokesman said by email that the company is reviewing the possibility of opening a Jacksonville office and then looking to hire former Sunshine State employees.

Heritage Insurance just went public in May by selling 6 million shares of stock at $11 each.

The stock, which trades on the New York Stock Exchange under the ticker “HRTG,” has jumped higher since the initial public offering, reaching as high as $15.38 last week.

Main Street America gets high rating

A much larger Jacksonville-based insurance company continues to be strong, according to insurance rating agency A.M. Best Co.

Main Street America Group announced last week that A.M. Best affirmed its “A” financial strength rating and “a-plus” issuer credit rating for the parent company and its nine property/casualty insurance subsidiaries.

According to a Main Street America news release, A.M. Best said “the ratings and outlooks reflect Main Street America Group’s focused marketing and branding strategies, disciplined underwriting philosophy and pricing segmentation, and have engendered Main Street America’s solid risk-adjusted capitalization, historically positive operating performance and diversified product offerings.”

Main Street America insures more than 650,000 customers in 36 states and passed $1 billion in premiums last year.

International Baler reports quarterly loss

International Baler Corp. reported a net loss of $92,387, or 2 cents a share, for the second quarter ended April 30.

The Jacksonville-based company, which makes recycling equipment, said in its quarterly Securities and Exchange Commission filing that sales in the quarter fell 5 percent to $2.8 million, due to the timing of shipments in its open order backlog.

International Baler said the net loss resulted from the lower shipments and higher administrative costs for directors’ fees and legal fees. It did not detail those fees in the filing.

Rayonier gets final approvals for spinoff

Rayonier Inc. last week said it received the final approvals it needs to complete its split into two separate publicly traded companies.

The spinoff of its performance fibers business into a new company called Rayonier Advanced Materials Inc. is scheduled to be completed Friday.

Rayonier said the Securities and Exchange Commission declared effective the registration statement for Rayonier Advanced Materials’ stock, which will begin trading on the New York Stock Exchange next Monday.

Rayonier also received a ruling from the Internal Revenue Service confirming that the spinoff will be tax free to its shareholders.

Rayonier Advanced Materials will trade under the ticker symbol “RYAM.” Rayonier Inc., which retains the company’s forest resources and real estate development businesses, will continue to trade under the ticker “RYN.”

Coach drops again on gloomy forecast

Coach Inc.’s stock continues to sink, falling to a four-year low Thursday after issuing a gloomy forecast at its Investor Day presentation.

Sterne, Agee & Leach analyst Ike Boruchow said in a research note that Coach announced plans to close about 20 percent of its full-price stores as part of its recovery plan.

Coach also projected compar-able-store sales, or sales at stores open for more than one year, will drop by a percentage in the mid-to-high 20s in the next fiscal year, Boruchow said.

He also said management’s projections imply earnings of about $1.50 to $2 for fiscal 2015, which would be well below the average analysts’ forecast of $2.79, according to Thomson Financial.

Coach’s stock fell as much as $4.19 to $35 Thursday. The stock closed the day down 8.9 percent at $35.69, making it the second biggest loser on the New York Stock Exchange Thursday.

“While the tone of the presentation was fairly downbeat, we were pleased to see the company finally admit to the issues that have plagued the business over the past 12 months,” Boruchow said in his research note.

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