Medtronic plays smart in M&A poker game

Medtronic's successful pursuit of Covidien throws a revealing light on the intense search for scale and pipeline by medical device and pharma companies. More importantly, it shows how cumbersome the US tax system has become for US- based international businesses.

A few weeks ago, Medtronic was reported to be pursuing British orthopaedic specialists Smith & Nephew. Executives at that company, also currently being stalked by Stryker, must now wonder if they were just part of a bluff in a complex game of corporate poker.

Maybe they were.

Buying Smith & Nephew would have consolidated Medtronic’s position in orthopaedics and brought it the 21 per cent tax rate now on offer in Britain.

The deal for Covidien is more ambitious. First, it significantly broadens the range of medical device sectors in which Medtronic has a significant presence, tapping Covidien’s strength in surgical devices.

Chief executive Omar Ishrak made a big play of the importance of becoming more involved with hospitals beyond being a simply an equipment supplier in the battle for a share of tighter health budgets.

Part of the thinking is that healthcare buyers will do more business with fewer companies offering a broader range of solutions. Ishrak, like counterparts at companies like Johnson & Johnson, is determined that Medtronic will be one of those core players.

Tax rate

The transaction also gives Medtronic access to Ireland’s 12.5 per cent business tax rate.

Covidien always sought to play down the tax card in explaining its Irish residence, despite its obvious advantage, and Medtronic executives yesterday were likewise focusing on the business case for the deal.

It is true that, at around 18 per cent, Medtronic’s average tax rate is lower than for many in the sector and reduces the advantage of a move of domicile here. But the company also has $14 billion in cash floating around outside the US, unable to be repatriated because of US taxes. An Irish domicile will free up options for those funds.

Tellingly, though, the terms of the deal allow Medtronic to walk away if the US changes its tax code to clamp down on such “inversions”. That is not unthinkable and the presence of the “get out” clause suffices to undermine the efforts of the two companies efforts yesterday to downplay the tax card.

Medtronic is familiar with the Irish tax advantage. Having entered the Irish market with the purchase of CR Bard in 1999, its Irish operations logged profits of €564 million on sales – entirely to other group companies – of €1.4 billion as recently as 2012, just before most of its business here was moved to unlimited status.

Exchange movements

Those businesses included an intellectual property arm, Medtronic Vascular Holding, which, thanks to positive foreign exchange movements, delivered pre-tax profit in year to April 2012 of €234.4 million, over €5 million ahead of the business unit’s turnover – and while incorporated in Ireland, not a cent was paid in tax that year by that business.