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Name of the Game: Tax Avoidance



August 01, 2014 – Comments (2) | RELATED TICKERS: VZ , T , TWC.DL

Location: TMFDeej's CAPS Blog

Author: TMFDeej

The name of the game in today's market is lowering taxes.  Earnings growth really isn't there for many companies in today's recovering yet still sluggish economy.  They only way for many of them to achieve sufficient growth to keep their stock prices rising is to either buy back stock to lower their number of outstanding shares and make their earnings look larger or to avoid taxes.  Tax avoidance actually is a double bonus for stocks, not only does it make companies' earnings higher but it usually increases the multiple that investors are willing to pay for those earnings.

Tax inversion is one way that companies have been attempting to lower their tax bills.  That essentially involves purchasing a foreign company and officially relocating your headquarters from the United States to a country that has a lower tax rate, such as Ireland.  This has been a big theme in the pharma sector.  Even  Walgreens (WAG) is rumored to be considering such a move.  To me, inversion seems sort of scummy, but I suppose we should have had corporate tax reform a long time ago and a lot less of this would be happening.  I personally wouldn't renounce my U.S. citizenship to pay a lower tax rate.  Pharma can get away with this, but I would think that a more consumer-facing company like a retailer might face significant blowback from consumers that could impact its business.  Who knows though, Budweiser has always advertised itself as being an American brand and it was bought out by a Brazilian company without any impact to its business that I have been able to see.

Another slightly less controversial way that companies try to lower their tax bills is to spinoff part of their assets into more tax-efficient vehicles, such as REITs, MLPs and YieldCos.   There probably isn't much of a difference between avoiding taxes like this and inversion, but it seems less unpatriotic than leaving the U.S. completely.  I have been playing this investment theme with a number of companies with quite a bit of success, from Oil Services International's (OIS) spinoff of Civeo Corporation (CVEO) to SunEdison's (SUNE) creation of a YieldCo.  I wrote about YieldCos here a month or so ago, Yield Co. creation can be a very profitable special situa...... .

Two new industries have gotten in on the REIT and MLP conversion game recently.  It started off late last week when word broke that a hedge fund called Perry Capital is trying to convince several paper companies to convert their plants into MLPs.  The paper industry has gone through a period of significant consolidation which many believe should enable companies to improve pricing.  Many investors believe that this makes them a good investment on their own, the ability to convert their plants into MLPs would add juice to that.

Perry Capital thinks that KapStone (KS) shares have as much as 98% upside (pre-pop) if it was to convert its mills into MLPs. Other companies that it contends would have significant upside, 50% to 60%, include International Paper (IP) and Rock-Tenn Company (RKT).

Perry Capital’s Plan To Double The Value Of The US Paper Industry

Spinning of mills into MLPs would generate cash, improve tax efficiency, and bring in yield hungry investors

I personally absolutely love the idea from an investment perspective, but I wonder if it is going to really happen.  Perry proposed the idea and owns stakes in IP, RKT and KS, but I don't know if it has actually engaged in any discussions with the companies yet and it remains to be seen if the IRS will allow it.  Given the fact that the plan places a cap on the amount of recycled materials that can be used in the manufacturing of paper of 25%, it actually looks like it discourages recycling.  It would be a pretty dumb move for the government to incentivise companies not to recycle, but who knows?  

This morning yet another industry has gotten in on the act, telecom.  Windstream (WIN) announced that the IRS is letting it spinoff certain wireline assets into a REIT.

Windstream to Spin Off Assets Into Publicly Traded REIT

WIN is the big "Winner", get it pretty punny huh, this morning with its stock up a whopping 25% on the news.  Other companies in the sector, even titans like Verizon (VZ) and AT&T (T) are up 3% to 4% on the news.  This could have huge implications for every company in the sector.  Why wouldn't they all do this?

I'm going to scour both the paper and telecom sectors today to see if I can pick up shares of a few companies that stand to benefit from this trend.  Ideally one would purchase stock in these companies before they officially announce that they are making such a move.  Doing so should enable one to get better prices. It has been one heck of a ride for WIN shareholders.  The company's stock has nearly doubled since February.  I didn't hear a peep about the potential for this conversion and I keep my ear very close to the ground for this sort of thing.  One has to wonder if there was any insider trading going on there.  I suspect that there was.

The next logical extension of this theme is cable companies.  What's the difference between cable companies and telecom?  Not much.  They both have wires in the ground.  Thinking that I was super smart and was going to beat everyone to the punch, I just looked up a quote on Cablevision (CVC) only to see that its stock is up 4.5% already.  Drats.  Time Warner (TWC) is already up over 3%. Comcast (CMCSA) is up 2.5%.

I suspect that the economic benefit to these companies and the ultimate benefit to shareholders, especially in the form of multiple expansion, exceeds these increases.  I'd love to hear others' thoughts on the subject.

Thanks for reading and commenting.  Have a great day.



2 Comments – Post Your Own

#1) On August 02, 2014 at 5:46 AM, Repurposed (< 20) wrote:

1.  Many of us learned from Ronald Reagan's tax reform that businesses that are based on tax avoidance can be erased in a Washington minute by a stroke of the tax pen.  This somehow strikes me as being the "last fool [small f] through the door."

2.  Let's see, spin off the cash generating part of the business made because interest rates ib debt us bear zero, you don't want to pay a dividend, and taxes are being avoided -- to a business tax device that puts the tax burden on the investor, just when interest rates may rise.  What could go wrong?  'errrr you want to see my MLP's that went out of business because of Reagan?

3.  Good blog! 

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#2) On August 02, 2014 at 10:19 PM, awallejr (35.47) wrote:

1. Yeah Congress could act but we are talking about a Congress that is lucky to pass any bill.

2.  I am tired of hearing how interest rates may rise.  They will but not to the point like they were in the late 70s and the 80s.  Why?  Because boomers are retirng and not spending and wage growth is non existant thanks to the tax code.

3. It was a good blog.

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