Thursday, April 24, 2014

Costs, Benefits, Taxes and Culture

Mergers are once again filling the headlines of our financial papers and as one who writes a merger blog, there are plenty of things we could discuss.  The Omnicom Publicis merger appears in danger, reportedly due to the resulting tax structure of the deal (although one can suspect other issues as well).  

Taxes also figure in the the $46 billion dollar offer of Valeant for Allergan.  According to an article in the Wall Street Journal, Valeant changed its domicile to Canada after its 2010 merger with Biovail.  As a result, it's tax rate is below 5%, offering a huge competitive advantage over companies in the United States.  Allergan is headquartered in California, so one strategy would be to move the business to Canada.  

But the Valeant Allergan deal is also newsworthy because of the differing cultures of the two companies.  Allergan is more focused on research and development, while Valeant is focused on sales.  Indeed, the planned strategy of Valeant is to reap savings by slashing the R & D spending of Allergan.  Certainly there can be value in R & D and that brings us to the nexus of the items we've talked about.

Consider three aspects of the Valeant, Allergan deal: taxes, culture and strategy.  There are three major claimants on EBITA - bondholders, debt holders and the government.  Reducing taxes increases funds available to the other claimants and can result in significant gains for equity.  

Merging companies with clashing cultures, however, is fraught with problems and can dramatically increase integration costs.  In this case, however, it is clear that Valeant is well aware of the culture/strategy issues and not afraid to confront them.  

So lets consider the pieces: taxes, culture, costs, benefits and strategy.  The value of a company and the value of any deal always come down to the basics - cash flows and risks.  We estimate value by discounting expected cash flows at a rate commensurate with the risks.

And cash flows can be increased in two major ways - growing the revenue or reducing the costs.  Both can be viable strategies and the success of any deal will hinge on the correct estimation of the costs and benefits and implementation of the specific tactics to bring them to fruition.  Both companies have been successful following different paths.  The question here is whether it makes sense for the paths to converge.

The market is predicting a higher, successful bid as the Allergan's stock price on Monday closed well above the $153. value offered by Valeant.  Valeant's stock price rose dramatically as well.  It will be interesting to follow this deal.  

All the best,


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