Tyco Merger Will Shift Johnson Controls' Tax Liability Overseas

by Leslie Picker

One of the first big mergers of the new year resembles a number of other deals in recent years in one crucial respect: It will allow an American corporation to move its headquarters to a country where corporate taxes are lower.
 
Johnson Controls, which introduced a device that could control room temperature some 130 years ago, has agreed to combine with Tyco. With the deal, Johnson Controls will relocate its headquarters from Milwaukee to Cork, Ireland, where Tyco is domiciled and where corporate taxes are lower than in the United States.
 
The move, known as an inversion, will enable the combined entity to save at least $150 million in annual tax payments, the companies said in announcing the deal on Monday.
 
Inversions were supposed to become harder to do after the Treasury Department issued new rules in September 2014 and even tougher ones in November. Presidential candidates on the campaign trail pilloried Pfizer in November, when it announced a $152 billion deal with Allergan that involved an inversion.
 
But the combination between Johnson Controls and Tyco is the 13th such deal to be announced in the last 16 months, according to data compiled by Dealogic.
 
It attracted some heat on Monday. “These efforts to shirk U.S. tax obligations leave American taxpayers holding the bag while corporations juice more revenues and profits,” said Hillary Clinton, a Democratic candidate for president. She said she had a plan to “block deals like Johnson Controls and Tyco, and place an exit tax on corporations that leave the country to lower their tax bill.”
 
A Democratic challenger, Senator Bernie Sanders, called the two companies “corporate deserters.” “If you want the advantages of being an American company then you can’t run away from America to avoid paying taxes,” he said.
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Representative Gwen Moore, a Democrat whose district includes Milwaukee, said she was “greatly disappointed” by the merger. “As long as House Republicans continue to block Democratic efforts to end corporate inversions, we can expect more U.S.-based companies to head overseas,” she said.
 
Johnson Controls paid a tax rate of about 19 percent in its last fiscal year, compared with a 14 percent rate for Tyco. The tax benefits from the deal come from “flexibility” and the ability to “accommodate changes in the future,” Robert Olson, the chief financial officer at Tyco, said in a phone interview
 
Shareholders in the American company are required to own less than 60 percent of the joint entity to pass muster for an inversion. Johnson Controls will own 56 percent of the new company, while Tyco shareholders will get the remaining 44 percent.
 
“We’re well within the guidelines that the I.R.S. has established, so we feel really good on it,” Mr. Olson said. “I know there have been some other deals about tax synergies, but this is really about the operating potential of the two companies.”
 
Alex Molinaroli, the chairman and chief executive of Johnson Controls, also said that the real impetus of the deal was the ability to better serve customers and share technological advances.
 
“The conversations we had were 100 percent centered around finding ways to grow in the building products market and take advantage of the technology innovation,” Mr. Molinaroli said in a phone interview.
 
Both companies have recently been working toward streamlining their businesses. Johnson Controls still plans to spin off its automotive seating and interior unit, to be named Adient, in the beginning of its fiscal year in 2017.
 
Shares of Adient will be distributed to both Johnson Controls and Tyco shareholders after the deal.
 
Right before the merger, Tyco will conduct a reverse stock split, whereby Tyco shareholders will receive a ratio of 0.955 shares for each of their existing Tyco shares. Johnson Controls shareholders could choose to receive one share in the combined company for every share of Johnson Controls that they own or receive $34.88 in cash.
 
The deal represents a premium of just 11 percent from Tyco’s close on Friday. Such a low premium has generated some speculation that another buyer, like Siemens or Schneider Electric, could make a competing bid for Tyco, according to Chris Pultz, who manages Kellner Capital’s merger-arbitrage fund.
 
But Mr. Pultz said that most traders expect Johnson Controls’ deal for Tyco to get done, adding that it was unlikely that the Treasury would come out with new guidelines on inversions before the election in November. The merger is expected to close by September — the end of the two companies’ fiscal years.
 
Shares of Tyco surged nearly 12 percent on Monday, its biggest one-day gain in nearly seven years. Shares of Johnson Controls fell 3.9 percent.
 
Tyco itself has changed its headquarters several times. The company first did an inversion in 1997 by acquiring ADT Ltd., and moving its headquarters to Bermuda. In 2009, shareholders voted to shift Tyco’s headquarters to Switzerland, and then five years later to Cork, Ireland.
 
The transaction signals the end of the Tyco name, which started in 1960 when the company was a small research laboratory for the United States government, later growing into an industrial giant through a series of diverse acquisitions. The name was marred in scandal in the early 2000s after Tyco’s chief, L. Dennis Kozlowski, was convicted of looting the company. Since then, the company has been broken up several times.
 
What remained of Tyco was a business focused on fire safety and security products with a market valuation of $13 billion last week. Those products will complement Johnson Controls, which makes a range of products, like air-conditioning units and industrial refrigeration, in serving commercial and residential buildings.
 
In addition to the tax benefits, the companies expect to create $500 million in savings by eliminating duplications in the business and exploiting the scale with their buildings business.
 
As a percentage of revenue, the benefits proposed in the deal have raised eyebrows among some analysts. The $650 million in total savings represents a mere 1.5 percent of the pro forma revenue of the combined company, which is below normal, said Nick Heymann, an analyst with William Blair & Company.
 
Adjusting for the separation of Adient, Johnson Controls will have an estimated $32 billion in revenue during the 2016 fiscal year, according to the statement. Tyco is projected to report $9.7 billion in revenue in 2016, estimates provided by Standard & Poor’s Capital IQ show.
 
Mr. Molinaroli will be chairman and chief executive of the combined company for 18 months after the deal closes. George R. Oliver, Tyco’s chief executive, will succeed Mr. Molinaroli as chief executive of the combined company.
 
Johnson Controls will receive about $3.9 billion in cash from the transaction, for which Tyco has secured about $4 billion in financing. The deal is still subject to approvals by regulators and shareholders of both Johnson Controls and Tyco.
 
Centerview Partners served as the lead financial adviser to Johnson Controls, while Lazard served as the lead financial adviser to Tyco. Barclays also advised Johnson Controls, while Goldman Sachs advised Tyco. Wachtell, Lipton, Rosen & Katz and A&L Goodbody were the legal advisers to Johnson Controls. Simpson Thacher & Bartlett and Arthur Cox advised Tyco. Citigroup is providing the financing for the transaction.
 
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