What Makes A Company American?

During the past 9 months, there have been speeches, sound bites, and editorial galore about the importance of corporate “loyalty” to America[1]. This phenomenon accelerated in April, as U.S.-based Pfizer (PFE) tried to acquire U.K.-based AstraZeneca (AZN), with the intention of domiciling the new combined entity in the “low-tax” United Kingdom.  Of course, AZN rejected the offer four times, wearing PFE down until it gave up. 

The mere thought that any U.S. company might be attracted toward a legal opportunity[2] to lower its corporate tax rate has proven to be an outrage to President Barack Obama, U.S.Treasury Secretary Jack Lew, and a whole coterie of senators and representatives. They accuse PFE (and others) of having been unpatriotic, acting like tax dodgers, and/or “turning their back on America”. 

However, the fact that PFE ended its pursuit of what would have been a blockbuster corporate takeover did not stop the outraged sound bites, since politicians are infamous for not letting the facts get in the way of an easy and “no-cost” opportunity to curry public favor. We can still find a few of our political leaders refer to PFE in the less than glowing terms I referred to earlier!

So, with that background, let me ask you a significant question: 

Which companies are “Most American”?

Go ahead now… start naming them!

After you’ve created your list, reflect on your thought process.  Did you create the list according to sentiment… or by virtue of some specific criteria? If the latter, did you place more emphasis upon:

1) The company must manufacture its product(s) in the United States;

2) Where the company produces its product(s) is not important, as long as the company is domiciled in the U.S.;

3) Where the company produces its product(s) is not important, but said products must be made of strictly American-made parts/components; or 

4) None of the above matters as long as the company’s product(s) is (are) designed by Americans.

If you think some of these criteria are a bit strange, they derive from a reputable national poll reported in 2013. Here is how respondents in the survey weighted those criteria (note that the survey choices were not mutually exclusive!): 

1) About 75% indicated that the company must manufacture its product(s) in the United States; 

2) 52% responded that where the company produces its product(s) is not important, as long as the company is domiciled in the U.S.;

3) 47% thought that where the company produces its product(s) is not important, but said products must be made of strictly American-made parts/components; or 

4) 25%[3] indicated that none of the above matters as long as the company’s product(s) is(are) designed by Americans.

A Harris Interactive Poll published in early 2013 reported the following responses to the question “What is the “most American” company?”:

1) Ford (F) received 15% of the vote;

2) General Motors (GM)[4] (Chevy) received 9%;

3) Coca-Cola (KO) garnered 4%.

OK, you might be thinking: “Now we’re getting somewhere!”

But I am thinking: “Really? Really?! Where are we getting?” 

The fact is that, in an increasing globalized economy, it is becoming harder and harder to develop hard and fast criteria regarding what really qualifies for an emotionally charged adjective such as “American”!

Here is what I think is a compelling case-in-point:

Cars.com publishes an annual ranking of the “Most American” cars… based on rigorous data gathering and a discernment process that incorporates specifics regarding:

                  1) Where the vehicle is built;

2) Where the parts/components are sourced (using a definition of “domestic” prescribed by federal regulation);

3) The volume of U.S. sales.[5]

Based on these metrics, the 2012 ranking showed that Ford only had one car in the “Top Ten”!!  In contrast, Toyota (TM) boasted three cars among the “Top Ten”, and Honda (HMC) had two models that high.  GM had three vehicles on that list, while the Jeep Liberty also made the top ten. 

Are you surprised?  Does it change your opinion regarding what constitutes “Most American”? 

The U.S. National Highway Traffic Safety Administration has admitted that there is no such thing as a 100% American-made car. A good economist might even suggest that, given the laws and realities of global economics, it would not even be efficient to try (on a large scale) to build such a car.  The global economy has changed the way companies must do business if they want to fulfill their fiduciary obligation to maximize shareholder value.

In case you are interested, here is the 2014 Cars.com “Most American” list:[6]

It doesn’t take a rocket scientist to recognize that today’s world economy is exceedingly more complicated than in 1794, 1984, or even 2004!!  The parameters related to what makes a company “American”… or for that matter, what constitutes an ambiguous concept such as “corporate patriotism”[7] … have become muddied, if not inscrutable.  In my opinion, globalization and the accelerating challenges facing U.S. corporations within our current fiercely competitive global marketplace, have moved us far beyond the era when we can afford to tolerate economic parochialism and/or jingoism within our federal and state government (much less the press). Instead, we need to expect our leaders to be more concerned about equipping and empowering U.S. business with a regulatory and legislative environment within which U.S. enterprises can: 

1) compete effectively;

2) succeed (grow revenue and earnings); and (thereby)

3) help “America Prosper” within the Global Economy! 

Regrettably, as things stand now, it would appear that our most highly placed federal leaders are focused solely upon maximizing tax revenue – economic competitiveness be damned.

In that vein, consider this graph: 

Hmmm, let’s think about this. Picture yourself the CEO of a U.S. corporation (or a board member of said company).  You know that your primary fiduciary obligation is to maximize shareholder value. You also know that your company is not a “citizen” of any particular nation, but carries the legal status of an entity “incorporated” within the bounds of a state (in the U.S.) or some foreign governmental authority. Due to the U.S. corporate tax law that has been in place since 2004 (after having been extensively analyzed, vetted, debated, negotiated, and (finally) approved by the U.S. Congress in response to the original “tax inversion” crisis), you now have the opportunity to buy an appealing overseas company and then domicile the new (combined) corporation within a lower corporate tax nation. In doing so, you will move your company from the world’s highest corporate tax rate to a legal rate (based upon the figures above) as low as 12.5% to 21%.

IMPORTANT:  As CEO, you know that no matter where you domicile the combined company, you will still (and always) pay the full U.S. corporate income tax rate on all income earned within the United States!!  That is a given. But your (soon to be) overseas tax domicile refrains from insisting upon “double taxation”!![8]

For a lot more detail on the “ins and outs” of U.S. corporate tax, see:[9] 

https://www.markettamer.com/blog/tax-evasion-or-inversion-a-short-history-case-study 

https://www.markettamer.com/blog/would-you-invert-a-view-from-the-ceos-chair

As I point out in those prior articles, one of the most anti-competitive burdens placed upon U.S. corporations by federal tax law is that “double taxation” – a financial drain not faced by their overseas competitors.

So, here we go, corporate CEO!!  Would you domicile your soon to be combined company in one of those lower-tax countries highlighted earlier?  If you do, you will increase net earnings… and if you judiciously trim administrative staff and real estate assets as the merger progresses (eliminating duplication and unnecessary expense) you will improve your performance with regard to increasing shareholder value!

Let’s take a quick look at two corporate “case studies” that happen to have been highlighted in recently published articles in this space: 

1) Burger King Worldwide, Inc. (BKW)

     see: https://www.markettamer.com/blog/what-60-year-old-company-has-surged-higher-over-the-last-2-years

 2) Walgreen Co. (WAG)

    see: https://www.markettamer.com/blog/abbott-is-miles-ahead-of-this-stock-in-the-news

CASE STUDY #1 

BKW is a fascinating case.  There is a compelling reason for the company name to include the term “Worldwide”.

1) As you can see below, almost 50% of BKW’s stores are already located outside the U.S., and international growth is higher than domestic growth.

2) BKW has been owned (in the past) by United Kingdom companies (most recently “Diageo”), and is currently majority owned by a Brazilian hedge fund (3G Capital);

Therefore, the “vision” of BKW has been globally focused for sometime now! Recently, as management surveyed the Quick Service (Casual) Restaurant space (QSR), it recognized an appealing strategic partner/acquisition just “north of the border”… Tim Hortons Inc. (THI). That potential partner offered these strengths: 

1) Growing faster than BKW:  

2) An exceptionally strong “brand” within Canada: 

3) The potential for greatly increased growth beyond Canada if/when piggybacked upon BKW’s existing expertise in international expansion:  

The decision by 3G Capital/BKW to acquire THI made such solid economic sense that the monumentally “American” citizen, patriot, taxpayer, and investment genius, Warren Buffett, stepped in to help finance the acquisition!!  Specifically, Buffett invested $3 billion in the preferred stock of the new company. That stake will produce an annual dividend totally a cool $270 million!  Yes, folks… a $270 million dividend amounts to a 9% yield![10] 

Interestingly, even Buffett’s stature as a preeminently “American” icon could not spare him the vitriol of politicians and commentators who accused him of hypocrisy for (in 2011) rising to the President’s support in his effort to raise taxes on the wealthy… while now condoning (via that $3 billion) the (supposed) flight of BKW from the U.S.!

Obviously, Buffett has had tired of the pedantic, distorted interpretations attached by others to his BKW investment!  This past week (the middle of September) Buffett defended himself with typical class and articulate reasoning… to whit:

1) Income tax is a sidelight within this transaction… not the “feature” rationale.

            a) During the past three years, the highest income tax paid by BKW has been $30 million… a mere pittance when compared with the price it paid to acquire THI ($11 billion).

2) Two of the most significant elements in recent “Inversions” have been[11]:

a) The transfer of “Intellectual Property” (IP) overseas to lower future tax payments;

         b) Gain new flexibility for “trapped cash sitting overseas”.

c) Buffet summarized his obvious point with this quote:

“There isn’t a whole lot of intellectual property to transfer with hamburgers. This is not a case of trapped cash, it’s not a cash of intellectual property.”

3) The pièce de résistance of Buffett’s argument can be gleaned by looking again at the map of the soon to be combined companies:

a) THI has 3,588 stores (and that’s just in Canada; it has another 859 locations in the US and one manufacturing facility);

b) Meanwhile, BKW has only the number of company owned stores that it needs for training and testing (remember, the BKW business is franchising, not owning).

c) So which company is “larger”? The answer is obvious, as is (as Buffett points out) why the combined entity will be based in Quebec, Canada.  

By this point, do you have any doubt regarding the logical rationale for the acquisition by BKW of THI…  a rationale that (despite the rhetoric from those that love an appealing sound bite) has little to do with taxes? BKW, THI, and 3G Capital know that once the acquisition is completed, this new entity will be the third largest QSR in the world…

and management is confident that, as BKW/THI grows, it will become the second largest… jumping over YUM Brands (YUM).[12]

CASE STUDY #2

When I penned my article about Walgreen Company (WAG), I warned that I had little confidence in the unity and focus of the company’s management and board. The overwhelming sense I received from my considerable research on WAG was that too many of its leaders were not “on the same page”.

I regret that when the time finally came for management to announce details regarding the completion of its acquisition of the European giant pharmacy, health, and beauty group, Alliance Boots[13] (an acquisition that was initiated in 2012), WAG did not meet the expectations of the market!

Consider these facts:

1) WAG has been under pressure in recent years regarding its declining profit margins … a trend that continues to be compounded by the pressures brought to bear on it by the increasing utilization of lower-margin generic drugs and the ongoing determination by government and private insurance programs to lower reimbursement levels. 

2) Alliance Boots has faced the same criticism for similar reasons.

3) For this reason, significant shareholder, JANA Partners (an activist hedge fund) has been turning up the heat on management to institute aggressive cost-cutting measures!

4) WAG has recently been paying tax at a rate of 37.5%, while Alliance Boots has been blessed with a mere 20% tax rate!

I want you to take a moment to imagine that you were the WAG CEO (instead of incumbent, Greg Wasson) in June, July, and early August as decisions were being made about the acquisition’s completion:

1) Your stock ripped higher on the firm expectation of an “Inversion”:  

2) You and your management team are under so much pressure that, in the past few months, you have had to push two members of your team “out the door”[14]; 

3) You are clear that the pricing pressures in your space will not let up anytime soon;

4) If you apply all of your persuasive ability and leadership skills, you can make a compelling case to complete the Alliance Boots acquisition as an “inversion”… thereby optimizing WAG’s position moving forward to both escape “double taxation” and enhance the new company’s “after tax” net earnings (which also increases profit margins)!

However, soon you receive direct phone calls from powerful individuals such as: 1) Rahm Emanuel, the current Chicago Mayor (your HQ office is located just 35 minutes north of there) and former Chief of Staff to President Obama;

 

and 2) the senior senator from Illinois, Democrat Richard Durbin (also the “Senate Majority Whip”, which makes him the second most powerful Democrat there).  You know that Emanuel is infamous for playing “political hardball”[15] And Durbin’s position in Washington, D.C. holds the potential to do you and WAG harm. Those gentlemen make it quite clear to you that proceeding with an “Inversion” would not be in your best interest.

Then you get several calls from Barry Rosenstein (the founder and managing partner of the activist hedge fund, JANA Partners, a major holder of WAG stock). Rosenstein reminds you that:

1) Wall Street is counting on you to do an “Inversion”,

2) An “inversion” will improve margins, and

3) Failure to do an “inversion” will bring serious harm upon WAG stock … something to which Rosenstein himself would take exception. 

In the press you read that if WAG goes with an “inversion”, it will be forsaking America, dodging taxes, and demonstrating a less than wholesome lack of patriotism.

Yes, in your mind you know that all of that is baloney (for the reasons I identified earlier). In addition, you know the facts are as follows (these points may sound absurd, but they do make an important point):

1) You will not be moving WAG stores out of the U.S. to foreign locations;

2) You will not be “outsourcing” the staffing of WAG stores overseas;

3) You will not move the WAG headquarters to Switzerland, therefore American jobs at the current HQ will be preserved… only the HQ for the combined holding company would be in Switzerland.

4) WAG will still faithfully and completely pay all income tax due to the U.S. Treasury from sales within the U.S. 

a) That hardly constitutes “dodging taxes”!

b) In fact, the total tax rate you’ll pay in Illinois (for example) will be:  35% federal; 9.5% Illinois.

Contrast all of the above with the supposedly “most American” company – Ford (F). Over recent decades F has moved so much of its assembly and the production of so many of it parts/components overseas that it only has one vehicle in the “Top Ten Most American” rankings!

In light of the above contrast, Is it fair for WAG to be called “Un-American” when all it would be doing is what it is supposed to do: maximize shareholder value within the parameters of existing U.S. law?

Then you discover that Senator Durbin has gone “public” with a campaign to vilify you and WAG. In July, Durbin wrote a letter to you that voiced his strenuous opposition to the idea of WAG moving its tax domicile.  In that letter, Durbin highlighted the fact that almost all of WAG’s 2013 profit ($2.5 billion) was the result of sales to U.S. citizens who pay taxes[16]. Then Durbin closed the letter with: “Is ‘the corner of happy and healthy’ somewhere in the Swiss Alps?”[17]  [Of course, Durbin made the letter public – it was a great campaign tool for his 2014 re-election campaign.]

After reading this letter, all you can say is: “Really?… Really?… This is the best that a supposedly well-educated, knowledgeable U.S. Senator can do? … Really?” You wonder to yourself whether Durbin knowingly or unknowingly distorted the facts: 

1) The “Corner of happy and healthy” refers to local drug stores, not the HQ!

2) The local stores are not moving anywhere, and the Deerfield HQ could remain (by U.S. law) the HQ for the Walgreens subsidiary of the new holding company (the holding company will have its HQ and domicile in Switzerland).

3) No U.S. jobs in stores would be lost; and (over time) only those Deerfield HQ jobs that constitute “duplication” would be lost… a corporate and governmental practice that occurs every day. 

If Durbin distorted the facts knowingly, that is quite disappointing.[18]  If the facts were distorted unknowingly, that speaks quite poorly for the quality of our national leadership. After all, Senator Durbin has served in Washington D.C. for over 41 years (a representative for 14 years and a senator since 1997). In fact, Senator Durbin was present and involved during the long and heated debate about the original “Inversion Crisis” during the period between 2000 and 2004, when the existing law that “fixed” that gapping hole in U.S. corporate tax law was passed.

You think to yourself once again: “Really?… he was there in 2004, for heaven’s sake. He helped create current law! You’d think he’d thoroughly know the provisions of that law! And if complying with that law is wrong or ‘unpatriotic’ – you’d think he might apologize for ‘getting it wrong’ in 2004!”

Obviously, Durbin and other political leaders want to make sure that WAG pays “its fair share”!![19] Wouldn’t paying 35% or more on all U.S. sales constitute a “fair share”? That would represent full compliance with current U.S. tax law!

Does Durbin pay his “fair share”? Let’s review the publically available facts:

1) Durbin and his wife earned $238,000 during 2013; in addition, their combined Social Security income was $50,805.

2) They own two homes in Illinois.

3) Based on those publically disclosed numbers, that placed them in the U.S. income tax bracket of 28%. Their “marginal tax rate” would be about 31.18%.

4) Their “effective rate” was just under 23%.

a) Now that is a lot less than either 28% or 31.18%.

b ) If Senator Durbin wanted to be patriotic and go beyond the amount required by law, he could have paid what WAG paid recently: 37.5%!  Instead,

c) Instead, Durbin chose to comply with current tax law by merely paying the amount due after all applicable, available tax deductions, exclusions, and credits![20] 

How is that different from what you feel you should do as WAG CEO in order to fulfill your fiduciary duty to shareholders?

So I will ask our readers again!  What would you have done with regard to “Inversion”?  This is an agonizingly tough decision, but (of course) that is why the CEO position exists – to make those tough decisions!

Well, in the real world, Greg Wasson recognized that he and WAG were going to be vilified from pillar to post by politicians like Durbin and Emanuel – for whom facts are not as important as ensuring that the government maximizes its revenue! 

Within various presentations and interviews, Wasson has shed light upon his decision to forsake “Inversion”, observing that the decision came only after “rigorous” and “extensive” review by the company board. Ultimately, it was discerned by them that the choice of a “complicated inversion” was “not the right course of action” for the company:

“The company and the board decided they needed a higher level of confidence to withstand what would most certainly be an intense, protracted review by the IRS and the potential downside of that for a period of time.”

Typical of the reaction of Wall Street to this decision is the following observation by George Hill, a senior analyst at Deutsche Bank:

“We recognize in the current environment that an inversion could have been politically and socially untenable.”  However, as Hill points out, shareholders were quite disappointed because (over the long term) the savings that would have been generated by an inversion far outweighed the short-term impact of negative publicity and the costs related to engineering that inversion.

For its part, the leaders at JANA Partners must have been extremely frustrated! I couldn’t find any public comment to this effect, but I am guessing that their private thoughts might have moved along these lines: “Wasson folded like a cheap tent!”

What are the consequences moving forward for WAG and its management, board, and shareholders?  They include at least the following:

1) A stock sitting over 13% below its recent high;

2) The extraction by JANA Partners of the sacrifice by WAG of conceding two company board seats to JANA[21];

3) The management and board of WAG will struggle for years to come with increasing margins and maximizing shareholder value as it wrestles with current and continuing headwinds (including the world’s highest corporate tax rate and “double taxation” … both serious competitive disadvantages to WAG within the global economy).

INVESTOR TAKEAWAY

The stories of BKW and WAG have hopefully provided you with both new information and helpful insights!

As you consider investment ideas, what lessons might be drawn from these stories? At least the following come to mind:

1) Wall Street doesn’t trust “promises”. Instead, it prefers the demonstration of

         a) Courageous and decisive corporate leadership;

         b) Decisions that ensure the enhancement of future shareholder value;

2) Be very careful and discerning with regard to the information sources you “trust”

a) A good deal of what we view on business television, hear on business radio, read in the financial press, and see within social media is slanted or distorted by misleading[22] information, less than thorough research, or “copycat” reporting. Never ever think: “Well it is published so it has to be true.”

b) As documented above, even the highest ranking and most experienced political leaders are known to distort the facts to suit their political objectives. Therefore, if you recognize a need to be skeptical of the press, then apply two to three times that degree of skepticism to anything that comes out of the mouth of a politician.

i) Also, be prepared for a coming onslaught of slanted tales from global political leaders regarding taxes.

ii) Just days ago, it was revealed that members of the Organization for Economic Cooperation and Development (OECD) have conspired to develop new corporate tax regulations designed to maximize governmental revenue.

• Most member nations are struggling with sizable deficits because they spend more than they receive;
• In their eyes, that is not a spending problem… merely a revenue issue that needs to be “fixed”.
• Therefore, the OECD is preparing to roll out new regulations that it want to be adopted by all member nations (and nations beyond) to ensure increasing tax revenue.

What insights can be gleaned from these lessons? Very briefly, let me suggest:

1) Warren Buffett and 3G Capital have demonstrated decisive, courageous corporate leadership.  Alas, Greg Wasson has fallen far short of that level of leadership exemplified by Buffett and 3G Capital.

2) Take a look again at the stock price of both BKW and WAG during the past two months in order to visually capture a glimpse of the type of leadership moves markets upwards!

3) Be a skeptic regarding everything you read or hear from any source … unless you have great confidence (from experience) that said source is honest, truthful, transparent, and reliable. [Forward looking hint: what we will be hearing and reading soon from the OECD will be slanted, distorted, and self-serving.]

Finally, I tried to resist, but I couldn’t!!  When asked to respond to what impact the impending coordinated effort by the OECD on sovereign corporate tax policies, one politician in particular offered a particularly insightful and “spot on” point![23].  This pithy comment came from Richard Bruton (Ireland’s Minister for Jobs, Enterprise and Innovation):

“As countries move away from other tax haven situations, a good country with a very clear, certain, regime like Ireland can stand to gain!”

When you review the long list of companies that have moved to a lower tax domicile and you see the most frequent destination for those companies, you’ll more fully understand both how subtle and how brilliant Bruton’s response is!  Hear hear![24]

DISCLOSURE: The author formerly owned WAG and currently owns options on BKW. (If shares were available on Washington DC, he’d short them.)  Nothing in this article is intended as a recommendation to buy or sell anything. Always consult with your financial advisor regarding changes in your portfolio – either subtractions or additions.

FOOTNOTES:

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