By JAMES L. DOTI / Contributing Writer
Published: July 11, 2014 Updated: 2:47 p.m.
Dave is the kind of person who’d be described by others as “one sharp cookie.” The MBA he worked hard for is serving him well. He earns a good living working at a job he loves. Dave’s boss thinks highly of him and is grooming him for “bigger things.” Dave’s modest car and comfortable home are already paid off. He is a widower with two college-age sons. He’s using savings from two tax-free college 529 accounts to pay their tuition.
Dave recently met Michelle, who is putting on a full-court press for his affections. Michelle seems to be a woman on the move. She drives an expensive car with over-the-top monthly payments. Her spacious home in the affluent part of town is heavily mortgaged.
In her attempts to woo Dave, Michelle points out that marriage would be a great opportunity for both of them. Evidently, her business startup is not yet profitable and has forced her to borrow heavily to keep things afloat. Michelle tells Dave that by marrying and filing jointly, their income tax obligation would be zero, since her huge interest payouts are deductible.
In one fell swoop, she argues, Dave could go from paying the maximum federal income tax rate to paying virtually nothing. Those tax savings could then be used to fund Michelle’s business and, even better, support additional business acquisitions she’s been considering. Living together in her home would allow Dave to sell his fully paid home and realize even more cash to fuel Michelle’s buying spree.
Together, Michelle tells Dave, they would be an economic powerhouse. Has Michelle made an offer too good to refuse?
Hardly. Dave and his two sons seem to be doing just fine. He has no debts and by funding his sons’ college education, he is investing in the future. Dave likes his job and is in line for a promotion. Marrying Michelle would certainly save him all the money he’s paying in income taxes. But what about all that debt he’d incur? Instead of paying the government income tax, he’d now be on the hook for paying the interest cost of all that debt. Even worse, Dave doesn’t really like Michelle that much.
If this were a novel, I think the reader would breathe a sigh of relief when Dave tells Michelle, “Thanks, but no thanks” for her indecent proposal.
But this tale of a rejected suitor hasn’t played out on a suburban cul-de-sac, but on Wall Street, in the merger battle between Allergan and Valeant Pharmaceuticals.
Like Dave and his sons, Irvine-based Allergan is doing just fine. It’s a highly profitable company, and its generous R&D budget strongly suggests that it is investing heavily in the future. Valeant, on the other hand, has lost money over the past year and barely eked out a small profit in the most-recent quarter. It is in debt to the tune of $17 billion, a burden amassed to fund Valeant’s buying binge of other pharmaceutical companies. And this total doesn’t include the $23 billion in additional debt Valeant would take on in its planned acquisition of Allergan.
Let’s put that debt in perspective. Allergan’s long-term debt-to-asset ratio, as of Dec. 31, 2013, was 19.8 percent ($2.1 billion to $10.6 billion). Valeant’s, on the other hand, was a whopping 62 percent ($17.2 billion to $28.1 billion). If Valeant’s attempt to take over Allergan succeeds, the long-term debt, as well as the assets, of the combined companies would increase by $23 billion, bringing the long-term debt-to-asset ratio to 68.6 percent ($42.3 billion to $61.7 billion).
In comparison, the average debt-to-asset ratio for other major pharmaceutical companies (Pfizer, Bristol Meyers Squibb, Roche, Glaxo Smith Kline, Johnson & Johnson), as of Dec. 31, 2013, was 20.5 percent, with the highest (Glaxo Smith Kline) at 36.7 percent and the lowest (Johnson & Johnson) at 10.0 percent. Note that the average debt-to-asset ratio of 20.5 percent is roughly in line with Allergan’s 19.8 percent ratio. None of these companies, however, comes even close to the 68.6 percent debt-to-asset ratio that would result from a Valeant takeover of Allergan.
But what about the vaulted tax savings from a Valeant-Allergan marriage? Current estimates suggest that Allergan’s tax rate would decrease from a current 26 percent to 8 percent. Since Allergan’s 26 percent tax rate resulted in it paying $458.3 million in income tax in 2013, a decrease to an 8 percent tax rate results in a significantly lower tax of $138.5 million that leads to tax savings of $319.8 million, a big sum to be sure.
Those tax savings, however, don’t come cheap. The additional $23 billion in debt necessary for the Valeant-Allergan marriage to occur needs to be funded. Conservatively assuming a 6 percent interest rate on new debt, the additional annual interest cost would be about $1.4 billion.
So here we have a Valeant proposal to Allergan predicated on paying an additional $1.4 billion in interest to save about $320 million in income tax. To say the least, this sounds like a bad way to start a marriage.
Just as Dave told Michelle in response to her proposal, Allergan CEO David Pyott is on firm ground when he politely tells Valeant CEO Michael Pearson, “Thanks, but no thanks.”
As an Allergan shareholder myself, I’d put it more bluntly: “Take a hike!”
James L. Doti is president and Donald Bren Distinguished Chair of Business and Economics at Chapman University.
Published: July 11, 2014 Updated: 2:47 p.m.
Dave is the kind of person who’d be described by others as “one sharp cookie.” The MBA he worked hard for is serving him well. He earns a good living working at a job he loves. Dave’s boss thinks highly of him and is grooming him for “bigger things.” Dave’s modest car and comfortable home are already paid off. He is a widower with two college-age sons. He’s using savings from two tax-free college 529 accounts to pay their tuition.
Dave recently met Michelle, who is putting on a full-court press for his affections. Michelle seems to be a woman on the move. She drives an expensive car with over-the-top monthly payments. Her spacious home in the affluent part of town is heavily mortgaged.
In her attempts to woo Dave, Michelle points out that marriage would be a great opportunity for both of them. Evidently, her business startup is not yet profitable and has forced her to borrow heavily to keep things afloat. Michelle tells Dave that by marrying and filing jointly, their income tax obligation would be zero, since her huge interest payouts are deductible.
In one fell swoop, she argues, Dave could go from paying the maximum federal income tax rate to paying virtually nothing. Those tax savings could then be used to fund Michelle’s business and, even better, support additional business acquisitions she’s been considering. Living together in her home would allow Dave to sell his fully paid home and realize even more cash to fuel Michelle’s buying spree.
Together, Michelle tells Dave, they would be an economic powerhouse. Has Michelle made an offer too good to refuse?
Hardly. Dave and his two sons seem to be doing just fine. He has no debts and by funding his sons’ college education, he is investing in the future. Dave likes his job and is in line for a promotion. Marrying Michelle would certainly save him all the money he’s paying in income taxes. But what about all that debt he’d incur? Instead of paying the government income tax, he’d now be on the hook for paying the interest cost of all that debt. Even worse, Dave doesn’t really like Michelle that much.
If this were a novel, I think the reader would breathe a sigh of relief when Dave tells Michelle, “Thanks, but no thanks” for her indecent proposal.
But this tale of a rejected suitor hasn’t played out on a suburban cul-de-sac, but on Wall Street, in the merger battle between Allergan and Valeant Pharmaceuticals.
Like Dave and his sons, Irvine-based Allergan is doing just fine. It’s a highly profitable company, and its generous R&D budget strongly suggests that it is investing heavily in the future. Valeant, on the other hand, has lost money over the past year and barely eked out a small profit in the most-recent quarter. It is in debt to the tune of $17 billion, a burden amassed to fund Valeant’s buying binge of other pharmaceutical companies. And this total doesn’t include the $23 billion in additional debt Valeant would take on in its planned acquisition of Allergan.
Let’s put that debt in perspective. Allergan’s long-term debt-to-asset ratio, as of Dec. 31, 2013, was 19.8 percent ($2.1 billion to $10.6 billion). Valeant’s, on the other hand, was a whopping 62 percent ($17.2 billion to $28.1 billion). If Valeant’s attempt to take over Allergan succeeds, the long-term debt, as well as the assets, of the combined companies would increase by $23 billion, bringing the long-term debt-to-asset ratio to 68.6 percent ($42.3 billion to $61.7 billion).
In comparison, the average debt-to-asset ratio for other major pharmaceutical companies (Pfizer, Bristol Meyers Squibb, Roche, Glaxo Smith Kline, Johnson & Johnson), as of Dec. 31, 2013, was 20.5 percent, with the highest (Glaxo Smith Kline) at 36.7 percent and the lowest (Johnson & Johnson) at 10.0 percent. Note that the average debt-to-asset ratio of 20.5 percent is roughly in line with Allergan’s 19.8 percent ratio. None of these companies, however, comes even close to the 68.6 percent debt-to-asset ratio that would result from a Valeant takeover of Allergan.
But what about the vaulted tax savings from a Valeant-Allergan marriage? Current estimates suggest that Allergan’s tax rate would decrease from a current 26 percent to 8 percent. Since Allergan’s 26 percent tax rate resulted in it paying $458.3 million in income tax in 2013, a decrease to an 8 percent tax rate results in a significantly lower tax of $138.5 million that leads to tax savings of $319.8 million, a big sum to be sure.
Those tax savings, however, don’t come cheap. The additional $23 billion in debt necessary for the Valeant-Allergan marriage to occur needs to be funded. Conservatively assuming a 6 percent interest rate on new debt, the additional annual interest cost would be about $1.4 billion.
So here we have a Valeant proposal to Allergan predicated on paying an additional $1.4 billion in interest to save about $320 million in income tax. To say the least, this sounds like a bad way to start a marriage.
Just as Dave told Michelle in response to her proposal, Allergan CEO David Pyott is on firm ground when he politely tells Valeant CEO Michael Pearson, “Thanks, but no thanks.”
As an Allergan shareholder myself, I’d put it more bluntly: “Take a hike!”
James L. Doti is president and Donald Bren Distinguished Chair of Business and Economics at Chapman University.