Foreknowledge, it appears, has blunted the M&A impact of anti-inversion regulations released earlier this month by the US Treasury Department. “The regulations merely implemented rules that everyone has known were coming for at least a year,” says Paul Seraganian in the New York office of Osler, Hoskin & Harcourt LLP. “So their effect has been baked into Canadian M&A deal flow for some time now.”
In other words, the bad news isn’t so bad because it’s old bad news, which as stock markets have demonstrated with regularity, can be less galling than new bad news. But given the downturn in our economy, attributable largely to falling oil prices, the fact that bad news is old news doesn’t make it good news.
The reality remains that the new regulations are aimed at slowing the flow of US corporate expatriations to countries with lower tax rates. Canada, as evidenced by Tim Hortons’ merger with Burger King in 2014 and by a spate of similar inversion transactions in the life-sciences sector, has benefitted greatly from the stampede from the US, which — apart from Japan — has the highest corporate tax rates in the world.
There’s no question that deal flow has slowed since the Treasury first announced its concern about 18 months ago. Still, it’s important to understand that the new regulations don’t prohibit or prevent inversion transactions. “The IRS has maximized the effectiveness of the tools available to them, but there are limits on what they can do,” Seraganian says.
One of the most significant of the new rules is aimed at “serial” or “super” inverters. “This is the rule that put an end to Pfizer’s $160-billion inversion transaction with Allergan in Ireland,” Seraganian says. “What the IRS is really not happy about are non-US companies that have become larger by gobbling up US companies and then taken on larger and larger targets.” Important as this may be, Seraganian believes it will “not be a significant game changer” for Canadian M&A.
Cheryl Reicin of Torys LLP, with offices in Toronto and New York, says the new regulations, including ones that limit the benefits of intra-company debt, are merely a stopgap and do not address the core issues. “It’s like plugging holes in a dyke, because the water will continue to rush until the US reduces tax rates,” she says. “Some of the larger mergers may not happen, and the ones that do happen may not get the same level of benefit, but inversion transactions will keep happening.”
Seraganian is of similar mind: “We believe that there will continue to be strong motivation for US corporations to pursue inversion-style transactions and that, given the strong economic and geographical connection between Canadian and US markets, Canada will become an increasingly attractive M&A destination for these US companies.”
Besides, it’s not necessarily the inversion phenomenon that’s created the M&A boom in life sciences. Among other things, there’s been a fundamental change in the pharmaceutical industry.
“We’re reading about inversion, but the real story is that M&A is the new R&D,” says Hillel Rosen in Davies Ward Phillips & Vineberg LLP’s Montreal office. “It incorporates the notion that you can be a pharma company without spending a dollar in research.”
Rosen points to his client Paladin Labs, acquired by Endo International, as an example. “Paladin sought out companies that had approved products or mature products or products that were on the cusp of being approved but didn’t attract a large enough market to interest big pharma, and acquired hundreds of products either by licensing them or acquiring the companies that owned the rights,” he says.
Laval, Quebec-based Valeant Pharmaceuticals International Inc. is another instance of a company that entered the big pharma market through acquisitions. “Valeant did it on a very large scale, but smaller deals that give rise to plenty of work for lawyers are around all over the place,” Rosen says.
Inversions aside, the rules could be far-reaching. “We expect that these new rules will spill over into mainstream cross-border M&A transactions that have no underlying ‘inversion’ motivation and may profoundly impact these deals in ways that may not be obvious or predictable,” Seraganian says.
“In particular, it seems clear that these new rules will have an important effect on the manner in which cross-border Canada-US acquisition transactions are structured, the way in which due diligence is done, and the way they are financed.”