Medtronic’s $43 Billion Covidien Buyout Is More Than Just A Tax Saving Deal

Global medical device maker Medtronic (NYSE: MDT) has agreed to buy healthcare and medical supplies major Covidien (NYSE:COV) in a cash-and-stock deal valued at close to $43 billion. This implies a premium of about 30% to Covidien’s previous closing price. If shareholders and regulatory agencies approve the acquisition, it is expected to close by the end of this year or early next year. ^[1]

The buyout is expected to help Medtronic reduce its global tax burden, as it plans to relocate its headquarters from the U.S. to Ireland, where corporate tax rates are considerably lower. It would also give the company lower-cost access to its $14 billion in cash, most of which is outside the U.S.. This was evident from Medtronic’s announcement to commit $10 billion in additional technological investments in the U.S. over the next 10 years. ^{[1] [2]}

Financial benefits aside, the deal is also likely to be a strategic win for Medtronic as Covidien’s expansive portfolio of surgical solutions, vascular therapies and patient care services will enhance Medtronic’s existing products portfolio and also create entry points into new areas such as medical supplies and emerging markets. The combined entity, with a presence in more than 150 countries, could also drive more value and improve operational efficiency by offering various healthcare and diagnostic products and services as a package to its customers. Covidien generated over $10 billion in revenue in 2013 compared to Medtronic’s $17 billion, with about 50% of sales coming from outside the U.S.

Our price estimate for Medtronic’s stock is currently around $60, which is about in line with the market price.

See our full analysis for Medtronic Inc.

Financial Benefits

Medtronic stated in its press release that it expects the transaction to be accretive to its cash earnings in FY 2016 and to GAAP earnings by FY 2018. The medical device maker also expects synergies related to optimization of their global back-office, manufacturing and supply-chain infrastructure to result in savings of at least $850 million by FY 2018. The company is also likely to benefit from potential revenue synergies with the addition of Covidien’s offerings to Medtronic’s existing products portfolio.

The deal is also being seen as an “inversion” attempt by Medtronic to cut its tax liabilities. Inversion is basically a situation where a company acquires another enterprise based in a different country for the purpose of lowering its corporate tax rates. A recent example of such an attempt was U.S.-based Pfizer‘s (NYSE:PFE) bid for London-headquartered pharmaceutical major AstraZeneca (NYSE:AZN). Inversion can be considered similar to another method employed by large corporations to avoid taxes called the Double Irish arrangement, where the company shifts its income from higher-tax countries to lower-tax ones through subsidiaries created for that purpose.

Although Medtronic is likely to gain from a reduction in its tax liabilities through this deal (considering that Ireland’s corporate tax rate is 12.5% compared to 35% in the U.S.), it is highly unlikely that the company would have gone ahead with the transaction if there were no strategic benefits to its business. ^[3]

Strategic Benefits

Covidien is a global healthcare products company with over 38,000 employees in 70 countries and products being sold in more than 150 countries. It sells a diverse range of products, primarily medical devices and medical supplies. Medical devices include surgical products, vascular products as well as respiratory and monitoring products. Medical supplies include monitoring and operating room products, needles and syringes, nursing care, skincare products, hydrogels and animal health products. ^[4]

Apart from certain vascular and surgical products, there is little product overlap between the two companies. We believe the Covidien acquisition should help Medtronic expand its presence in the minimally-invasive surgical market. Covidien is also likely to help Medtronic in expanding operations in emerging markets, where it has an extensive R&D and manufacturing presence. Medtronic has reported robust sales growth from its emerging market operations in the last few quarters, but there is still considerable room for improvement. Emerging markets including Asia-Pacific, South Asia, Africa and the Middle East currently contribute about 13% of its overall revenues and this deal is likely to help improve their contribution going forward.

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1. Press Release, Medtronic, June 15 2014 [↩] [↩]
2. Medtronic to buy Covidien for $42.9 billion, rebase in Ireland, Reuters, June 16 2014 [↩]
3. Corporate Tax Rates, KPMG, 2014 [↩]
4. Covidien 2013 Annual Report [↩]