Drug companies’ ‘tax inversion’ dodge could backfire

Could healthcare shares be good for your wealth? Ian Cowie thinks so. In The Sunday Times at the weekend, he said that he was buying shares in Worldwide Healthcare investment trust at a price 16% below their level only a month ago.

The biotech sector might have taken a tumble, he says, and some of the biggest healthcare stocks might have a few problems (GSK is caught up in a bribery scandal, for example), but healthcare remains an excellent place to be: “as the global population gets older and richer demand for healthcare is likely to rise.”

I’m entirely with him on this idea. I’m also keen on the WH Trust; and the sector has vindicated his views almost instantly with this week’s blizzard of stock boosting deals (see this week’s Moneyweek out on Friday for more on this).

But within all the talk about the future of the sector and the great gains to be made along the way, one small thing is bothering me about some of the big US listed stocks in healthcare and beyond.

In The Times today, Susan Thompson notes that “a common thread linking the bulk of the $90bn healthcare deals done in the past year is tax.” The holy grail for drugs companies is not so much the deals themselves, but the way that, if correctly structured, the deals can allow companies to relocate their headquarters for tax purposes – something known as ‘tax inversion’.

The prospect of an inversion has apparently been raised with regard to the proposed deal between Pfizer and AstraZeneca and “most commentators agree that America’s corporate tax regime has been a driving factor in recent inversion transactions” (this Bloomberg piece is interesting on the subject).

A large number of US companies (Pfizer included) have huge volumes of cash overseas that, as City AM notes, they “loath to repatriate” for fear of the hefty tax bills that might follow – hence the need to find foreign acquisitions or inversion possibilities that might use up some cash and offer a new low-tax headquarters.

But there’s a question here about valuations. As tweeter Shinsei1967 notes, the traditional (and I think most valid) way of valuing a company is to add up the future stream of income expected from its dividend payments and give it a present value.

So, what happens to the valuations of companies that won’t repatriate cash and so won’t pay out the dividends they should (and of course can’t acquire other US companies)?

Pfizer might be planning to tax invert now, but surely firms in similar positions should see their shares trade at large discounts to their net asset values – rather as those in investment trusts that hold only illiquid assets do – at least until they too invert or there is a hint that the US corporation tax regime might relax. Cash is always worth less when you can’t get your hands on it.

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