At Tamim, we speak to hundreds of DIY investors on a weekly basis, as they seek to achieve improved returns from their investment portfolio. A common theme we come across every week is where an investor has decided not to sell their shares due to capital gains tax implications. BHP seems to be one of the most common coming across our desk at present.
This week we discuss Pfizer and shed light on why making investment decisions based on a tax outcome as opposed to an investment outcome is not always optimal. We ask DIY investors reading this to reflect on any poor investment decisions made in the past that were a result of worrying too much about the effect of taking a capital gain. Prudent portfolio management is the key to long-term investment success. After all, you can’t go broke realising a profit.
- Strong pipeline of drugs albeit mature – Lipitor (cholesterol), Viagra and Celebrex (anti inflammatory). These drugs were heavily geared to an aging population which is the current situation in the USA, and also that of the rest of the world which buys them
- Acquisitions of Warner Lambert, Pharmacia and Wyeth in 2000’s all showed that the company could develop and buy growth. These acquisitions are getting harder (eg Astra Zeneca proposal was effectively blocked by UK politicians)
- No material problems with governance or accounting
We are now at the point where we believe the risk/reward trade-off is no longer in our favour, and our proprietary VMQ score while still favourable is not at the attractive levels it was when we first entered the position.
Pfizer is also about to do a tax inversion deal. As we wrote in late 2015 as we pondered our investment:
“It has been widely documented that a key rationale of the Pfizer-Allergan mega merger is tax minimisation. By re-domiciling the company in Ireland, Allergan’s home, Pfizer will have the ability to avoid US taxes on $128bn of profits earned outside the United States.” A tactic commonly referred to as ‘tax inversion’.
Exploitation of this tax ‘loophole’, while great for potentially increasing shareholder value in the short term (and is not a sustainable way of growing earnings), presents a dilemma for the US government which has the authority to block the transaction. If they allow it to happen will we see a further rush of companies looking to follow in Pfizer’s footsteps? Or, could this deal be the catalyst for legislators to review and overhaul US corporate tax policy, acknowledging that high corporate taxes on USA based companies are not the way to encourage inward business investment?
We are troubled by this deal not because of the tax benefits, but because it appears to be the only reason to do the deal. Corporate finance 101 taught us that the underlying purpose of a merger was to achieve a result of 1+1>2. Attempted tax arbitrage may fall into this category but for the wrong reasons.
So, if the regulators and governments allow the merger to proceed, it is our view that Pfizer may have just bitten off more than they can chew…doing something for tax reasons alone is seldom a good reason.
This is true for both business and portfolio investing, “Tax alone shouldn’t drive the decision.”
The complexities associated with merging two companies of enormous size and differing cultures across multiple jurisdictions will alone present its own series of problems and if there are no true benefits to be ground out then it’s a deal that leaves us lukewarm.
The above scenario and resulting thought process is how we encourage you to think about your personal investments. If there are clouds gathering over a company within your portfolio, don’t ignore the warning signs as we are starting to see happening with Pfizer. This even more true if tax implications are the sole reason for your decision.