During his presidential campaign, Donald Trump had stressed on tax reforms and promised that bringing down corporate tax would be his top priority as the President of the United States. Keeping his words, Trump proposed changes in tax rates for both individuals and corporates to stimulate economic growth as well as employment growth.
The plan proposes to lower the current corporate tax rate of 35%, one of the highest in the world, to 15%. This is expected to favorably impact the post-tax earnings of companies. A territorial tax system (tax on only domestic income) has also been proposed for American companies so as to create a level playing field. It also suggests the elimination of special tax breaks for companies.
Another major reform proposed is the repatriation of trillions of dollars held as cash reserve overseas by the companies with global operations for one-time tax (reportedly 10%). A similar tax move was made for bringing in overseas cash reserves by the Bush administration in 2004 for one-time tax of 5.25%. A number of companies repatriated an amount exceeding $300 billion.
The current tax code allows tax repatriation at 35% rate. However, it gives tax credit for the amount of tax paid in overseas country.
The reforms have been proposed to create new jobs and aid economic growth through expanded investment as more cash will available to companies through tax cuts and repatriation. However, the extent to which these steps will be successful is uncertain. A large portion of the repatriated cash in 2004 was used to fund share buybacks and dividend payments. Though the buybacks fueled a stock rally, there was no actual economic growth.
The tax reforms are expected to benefit companies which have operations around the globe. A similar buyback this time is also expected to help the stocks grow.
Large cap pharma companies based in the United Sates with major operations worldwide including J&J, Amgen Inc. AMGN, Gilead Sciences and others are sitting on huge pile of cash reserves stashed in overseas countries. The repatriation will benefit these large drug/biotech companies more than the tax savings due to rate cuts
Moreover, repatriation of cash held overseas will create a surplus in domestic cash reserve, which may fuel merger & acquisition (M&A) in the sector. The industry has seen only two major acquisitions this year, Actelion by Johnson & Johnson JNJ and Kite Pharma, Inc. KITE by Gilead Sciences, Inc. GILD, which is expected to close by 2017 end.
Let’s discuss the impact of tax reform on the some drug/biotech giants.
Johnson & Johnson (JNJ)
Johnson & Johnson (NYSE:JNJ) is a well-known brand all over the world catering to a wide variety of medical needs. The company has paid tax at an effective rate of 16.5%, 19.7% and 20.6% for 2016, 2015 and 2014, respectively. Therefore, a revision of tax rate to 15% will not bring a huge positive change in post-tax earnings.
As of June end, J&J had $12.9 billion in cash reserve, down almost 70% from 2016 year end. The company has used a major chunk of its cash reserves in 2017. Hence, J&J is expected to be least impacted by these reforms.
Amgen, Inc. (AMGN)
Amgen, Inc. (NASDAQ:AMGN) has a strong presence in the oncology/hematology, cardiovascular disease, inflammation, bone health and nephrology markets. The effective tax rate for Amgen in 2016, 2015 and 2014 were 15.7%, 13% and 7.6%, respectively. Hence, a tax rate cut will have minimal effect. Amgen had nearly $35 billion in overseas cash as of 2016 fiscal end, per a Bloomberg report.
The total cash reserve of the company has changed minimally in the first six months of 2017. So, the repatriation reform may initiate a buyback. Moreover, after 10% tax, it will have more than $30 billion in domestic cash reserve, if the total overseas cash is repatriated. This increase in domestic cash can also be used in acquiring new drug technologies like CAR-T therapy.
Gilead Sciences, Inc. (GILD)
Gilead Sciences, Inc. (NASDAQ:GILD) recently announced its plan to acquire Kite Pharma for nearly $12 billion, adding the latter’s CAR-T therapy candidate to its pipeline. Gilead is planning to complete the acquisition through a combination of cash and debt. Per a Bloomberg report, Gilead had $29.3 billion of cash reserves in overseas countries at the end of 2016. A repatriation will help the company to pay off the debt quickly. The effective tax rate has been between 16% and 21%, which suggests a minimal impact due to tax rate cut.
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