Controlled inversion

25 Jan 2016 By Kevin Allison

Johnson Controls’ $16 billion purchase of Tyco International is insured against politics. The U.S. building-controls specialist is risking politicians’ ire by shifting its tax headquarters overseas after it combines with its Ireland-based rival. But with an expected $500 million of yearly savings and a low 11 percent premium for Tyco’s owners, tax reduction is of secondary importance.

In a complex deal that smacks of late-cycle merger action, Milwaukee-based Johnson’s own shareholders are being handed $3.9 billion in cash to reduce the share count to levels that allow a shift of tax domicile to happen. At its center, though, Johnson is in effect paying roughly $1.4 billion above Tyco’s market value on Friday. The modest premium partly reflects a relatively even split of interests, with Tyco owners set to hold 44 percent of the combined company and therefore collect nearly half of any additional upside.

Johnson Controls-Tyco International deal

Source: REUTERS/Richard Beales, Kevin Allison

Other multibillion-dollar so-called tax inversions have attracted criticism from Washington lawmakers. Johnson’s decision to proceed may reflect a calculated bet on gridlock. Still, even if Congress somehow manages to get its act together and stop U.S. companies from decamping overseas for the tax savings, the financial risk looks manageable in this case.

The deal depends far less heavily on slashing the combined tax rate than, say, drugmaker Pfizer’s $160 billion deal to buy Botox producer Allergan. The companies reckon that adding Tyco’s fire and security systems to Johnson’s heating controls and the like will allow them to rip out at least $500 million a year in operating costs within three years.

Tax those at a blend of the two companies’ typical tax rates – call it 20 percent – and put them on a multiple of 10 times, and they’re worth around $3.3 billion after allowing for the delay in realizing them. That’s more than double the capitalized value of $150 million a year of anticipated tax savings.

It’s also more than double the premium being paid to Tyco shareholders. Unlike Pfizer, say, Johnson doesn’t need the tax benefits for the deal to add value if cost reductions work out as expected. Any savings at Uncle Sam’s expense will be gravy, not meat.


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