Just Say No To Drugs...Unless

Mint – Blain’s Morning Porridge  - April 29 2014

Just say no to drugs.. Unless they are really really good ones...

Are we on the verge of a Tsunami of global M&A activity? GE and Alstom. Pfizer and AstraZeneca. Hum… Ho.. Perhaps! Don’t forget the last big year for M&A was 2007 – and that didn’t end particularly well.. But, markets have no memory, and love the confident signals an outbreak of M&A-itus sends as the Billy-big-wallets bestride the news flow.

Curb your enthusiasm. What’s the real driver? I’d look to Apple issuing $17bn of bonds to pay off antsy shareholders for the real story. It’s all about tax – avoiding it. It should not be, but it is. In the vacant vacuum of long-term US political gridlock, corporate America is gaming the ossified tax codes to satisfy “stakeholders”. (Note – I deliberately said stakeholders (to ensure all the vested interests are noted) rather than just stockholders.)

Someone is going to chide me for being negative and remind me that “free markets thrive on globalisation and acquisition activity”. Maybe they do, but tax avoidance does not benefit the greater good. The current rash of global activity is about tax optimisation - US firms are looking to put cash out of reach of the US authorities, to minimise punitive tax hits if they repatriate funds, and meanwhile keep shareholders smiling.

The reality is the unintended consequences of US tax laws and political gridlock means Corporate USA is stuck with around 60% of assets overseas. Last year – the top 50 US firms were sitting on corporate cash piles of over $900bn – Moody’s say that figure is now well over $1 trillion - meaning the 50 largest US firms have around $600bn of cash to blow internationally. Most of the cash is sitting with tech firms – famously Apple, Google, Microsoft and Oracle - but next up are healthcare/Pharma, consumer products, energy and the autos. Last year Amgen held over 78% of its $25bn pile overseas.

That money could just sit there, giving corporate treasurers the headache of doing something with it. But now the global economy looks set to tick higher which means the pressure on companies to perform is mounting. Perhaps the greatest worry about Apple’s new bond issue to pay extra dividends isn’t the fact it's debt funding a dividend, but that Tim Cook caved into the stockholders like Einhorn and is meeting their demands for cash backs. Stockholders want to see cash piles working… or they want it!

Some will say it doesn’t matter how companies make money – if they make profits by selling more and better widgets, then that is fantastic. Problem is, if the company is making more widgets, the workers notice and demand more pay. Others say making profits by paying less tax is even better. That ensures the cash then circulates around the economy from the wallets of shareholders. Horsefeathers. It simply means workers don’t have earnings to drive consumption, while cash that could have circulated around the economy from tax revenues being invested in social goods and services doesn’t happen and further exacerbates income inequality.

It’s a classic problem of the commons. Either forgone tax revenue fuels stockholders buying more private jets, or the US Air Force gets new F-35s. Or rich men feast on the last caviar, while poor people ransack the food banks.

I am particularly bitter about tax collection. After three years being hounded by the HRMC over pension contributions, I was forced to pay despite its being blatantly unfair. No appeal, no justice – “either pay or we tear you kids hearts out” was the only offer they made. Yet corporates pay billions to avoid paying tax, and tax offices around the world connive at it; 10 minutes spent chasing a corporate over tax would yield far more than the misery created chasing earners!

Countries where companies have over $1 trillion cash piles aren’t broke. They just ain't collecting taxes properly. If politicians can’t ensure taxes are properly collected they should be voted out – er… but that’s another problem of politics: we will be told few turkeys will vote for higher taxes. They would if they knew the tax burden would shift from households to corporates, and corporates should be equally happy if higher disposable incomes drive consumption.

And in the case of the broken US tax codes, political gridlock hurts everyone one as it would clearly be better for everyone if US companies could repatriate their dosh to create domestic jobs and boost incomes. Sort out taxes! 

(Sorry about the above.. something stirred my socialism genes… I’m back on the medication…)

So it’s no surprise Pharma is in the news with Pfizer finally playing its cards re AstraZeneca. There are plenty of good reasons to buy the UK firm – mostly in terms of selling drugs to the UK’s monolithic NHS, but being able to show investors a deal that works primarily because of the tax advantages of moving to the UK isn’t a great one…

And speaking of M&A, you have to laugh at the French reaction to GE... but their hearts might be in the right place…. They just have to engage brains..

Meanwhile, and elsewhere.. I’ve said a few times “when a German bank issues a CoCo, then run away…”. After a small beat on expected fixed income results, Deutsche Bank’s deal is roadshowing a low trigger €1.5bn deal next week. The deal will include write-back language. But the problem with CoCos/AT1s is most of the juice has already been taken out the market – deals have become way too tight relative to the unquantifiable risks. However, we think now is the time to be selectively switching from the more vulnerable overpriced deals into the names with loads of surplus capital. For instance, DB’s T1 capital level is a paltry 9.7% compared to Danske Bank at 19% plus!

Another clue to the market is a breakdown of DB’s results. Decreasing client activity in “difficult trading environment” they said. Separately, global FICC revenues (Fixed Income, Commodities and Currency income for the leading five US banks has fallen 13% to $15bn.. ouch. 

Meanwhile, red faces and the sound of credibility flying out the door at Bank of America. After convincing the Fed its capital plans were sound, the bank admitted it had “mistakenly” inflated capital levels by about $4bn – pretty much wiping out its plans for a $4bn share repurchase. It turns out to have been on a valuation of structured Merrill paper (oops) held since the acquisition!

On with the rest of the day…

Bill Blain

0207 786 3877

[email protected]

[email protected]

 

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