Hedge Funds Wage Billions on Tax Inversion Deals

August 7, 2014

With most of the US stock markets trading close to their all-time high values, finding attractive investment opportunities has become difficult for hedge funds. Faced with limited investment opportunities, hedge funds are becoming creative in their approach to deploying capital. One such technique currently in favor among hedge funds is buying large stakes in companies and pushing the management to buy a foreign company and move the headquarters overseas to escape the high corporate tax rate in the U.S. Forbes is reporting that there is a rush among hedge funds and companies to get inversion deals done before the government, which is expected to lose several billions in tax revenue as a result of these deals, changes the laws to make it harder to do such transactions.

Tax Inversion

A tax inversion deal, in simple terms, enables a U.S. company to lower its tax rate. In these deals, a U.S. company buys a foreign target and adopts the new country’s domicile. In some cases, an inversion can help U.S. companies lower their tax rate to less than 10 percent from as high as 35 percent. For a tax inversion deal to take effect, shareholders of the acquired foreign company must own a minimum of 20 percent in stock of the resulting entity.

Hedge Funds Pushing for Inversion Deals

Tax inversion has been in practice for over three decades and according to data provided by the Congressional Research Service, about 47 companies engaged in tax inversion deals in the last ten years. But the pace has accelerated in the last year and inversion deals with strong backing from prominent hedge funds have been especially popular among pharmaceutical and life-sciences companies which have large cash holdings overseas.

Among the recent deals involving active hedge fund participation include the $5.6 billion acquisition of California-based Questcor Pharmaceuticals by Ireland headquartered Mallinckrodt Plc. The deal will lower Questcor’s tax rate by 10 percent. Hedge fund billionaire John Paulson who was among the few managers to make big gains during the financial crisis by betting against subprime mortgages and Barry Rosenstein of activist fund Jana Partners held large stakes in Mallinckrodt and publicly supported the deal.

In April, another prominent activist hedge fund, Pershing Square, made a $4 billion investment for a 10 percent stake in California pharmaceutical company Allergan and is working to sell the company in a $45 billion deal to Canada’s Valeant Pharmaceuticals which has its tax domicile in Barbados. Also in the same month, America’s biggest pharmacy chain, Walgreen, came under pressure from activist hedge funds Jana Partners and Corvex Management as well as from billionaire Dan Och’s Och-Ziff Capital Management hedge fund to move to Europe for tax gains through a $16 billion takeover of Alliance Boots, a European pharmacy chain based in Switzerland.

Among the other inversion deals that are pending completion include Medtronic’s $42.9 billion acquisition of Irish medical device maker Covidien Plc and AbbVie Inc’s $54 billion acquisition of Irish pharmaceutical company Shire Plc.

Commenting on the wave of inversion deals this year, Dr. Jacob Gottlieb, who runs the $7 billion New York hedge fund Visium Asset Management, says, “It’s very simple when the math works.” Another hedge fund manager Ted Chen of event driven fund Water Island Capital says “Every fund in New York is looking for stocks that could rise from inversions,” adding, “It has become a mainstream thing.”

Relevance to Job Market

While the frenzy towards tax inversion deals by hedge funds could have been prompted by an urgency to take advantage of the loophole while it exists, it could also be due to fewer predictable opportunities elsewhere in the market. The job market will likely remain weak if this surge in inversion deals is a result of limited investment opportunities for hedge funds in the current market.

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