Medtronic has been a good stock over the years for Dolores Rodenborg.
The 84-year-old Eagan resident said she admires Medtronic co-founder Earl Bakken, and has benefited financially from considerable growth in the stock’s value since the late 1970s.
But a deal announced this summer for Medtronic to acquire Ireland-based Covidien and move its headquarters to Dublin has frustrated Rodenborg and other long-time shareholders in the Fridley-based company.
The structure of the deal would have investors such as Rodenborg cash in old Medtronic stock for shares in a new Irish parent company, Medtronic PLC, and the transaction would trigger tax on capital gains in the old Medtronic stock. For Rodenborg, that could mean about $100,000 in taxes.
“It’s going to hurt,” she said.
And Rodenborg is not alone.
At the Mairs & Power advisory firm in St. Paul, a number of investors have held Medtronic stock for years, and were hoping to avoid tax on capital gains by leaving shares to an estate or heir, said Mark Henneman, an executive vice president. That won’t be possible if the Covidien deal goes through.
“The structure of this deal makes it a taxable event,” Henneman said. “Whatever basis the shareholder has will be stepped up to the current price, and that difference will be subject to capital gains tax.”
One hypothetical long-time investor, with 1,000 shares, for example, could have a split-adjusted basis price for the stock of 14 cents per share.
That’s just a fraction of Medtronic’s $62.90 closing price last week.
With the same holdings valued at last week’s price, the investor would realize a gain of more than $60,000 with the Covidien deal, said Steve Gilbertson, a financial planner with Accredited Investors in Edina. In a worst case scenario, tax on the hypothetical investor’s capital gains, plus other state and federal taxes, could run as high as 35 percent, Gilbertson said, or more than $20,000.
“They’re very disappointed,” Henneman said of long-term investors. “We’ve got a number of clients that have held this stock for a long period of time, so
their capital gains are significant.”
Even some investors who expected to realize capital gains during their lifetime have been frustrated by the tax implications of Medtronic transaction, said Gilbertson.
“By having the significant capital gains taxed all at once, it might effectively push them up to a higher tax rate than if they could have sold it over a number of years,” Gilbertson said.
LONG LOCAL HISTORY
Medtronic has bought a lot of companies over the years, but the Covidien deal is unusual in triggering a tax hit for shareholders. The company says it has been trying to make investors aware of tax implications since announcing the proposed acquisition in June.
“Every shareholder, including senior executives, are subject to capital gains tax,” said Medtronic spokesman Fernando Vivanco in a statement.
Terms of the deal would have Medtronic pay about $43 billion in cash and stock for Covidien, thereby creating a medical products giant with 87,000 employees in more than 150 countries. While the executive offices would move to Ireland for tax purposes, Medtronic officials say the operational headquarters will remain in Minnesota.
Such deals are known as “inversions,” and the Covidien proposal has placed Medtronic in the middle of a national debate over how to reform federal tax policy. Some are skeptical that large reforms can happen quickly with partisan divisions in Washington, D.C., so there’s proposed legislation to make inversions more difficult — at least in the near term.
The Covidien acquisition would be the largest in Medtronic’s 65-year history. Bakken and his brother-in-law Palmer Hermundslie founded the legendary company in a garage in northeast Minneapolis in 1949. Its growth has helped create a vibrant cluster of medical device manufacturers in the Twin Cities and serves as a storied chapter of local innovation for the regional economy.
Medtronic has received many calls and emails from shareholders asking questions about tax implications from the deal, Vivanco said. They’ve also been discussed at a series of meetings with employees — Medtronic employs about 8,000 in Minnesota.
Moving the headquarters to Ireland is the most “financially efficient” structure for the company, Vivanco said. Otherwise, Medtronic might have to pay U.S. taxes on Covidien’s cash going forward.
“The transaction is primarily driven by the strategic decision to further the company’s mission … rather than by tax considerations,” Vivanco said in a statement. “The transaction will support Medtronic’s commitment to continually invest and innovate and create long-term value for shareholders.”
PATIENCE MAY PAY OFF
If some long-time shareholders are concerned about the tax hit they face with the Covidien deal, institutional investors might be less worried, said Jerry Caruso of the University of Minnesota’s Carlson School of Management.
Fund managers might be more tolerant of the near-term tax hit because they believe the deal will generate growth for Medtronic in the long run, Caruso said. What’s more, mutual fund performance typically is evaluated based on pre-tax returns.
Institutional investors also are more likely to have been in and out of the stock over the years, meaning the cost basis for their shares is less likely to be dwarfed by the current market price, Caruso said.
“It would be highly unusual for a mutual fund to own a stock more than 10 years,” he said.
Two mutual funds at Mairs & Power own Medtronic shares. The advisory firm is still evaluating the Covidien deal and hasn’t decided how it will vote on the proposed acquisition, Henneman said.
Some long-time investors likely will vote against the deal, he said, even though they recognize it probably can’t be stopped. Some shareholders also are considering gifting Medtronic shares to a nonprofit group as a way to avoid taxes.
“If someone was planning to make gifts to an organization — maybe they would have written a check for $10,000,” Henneman said. “Now, they might instead transfer $10,000 worth of Medtronic stock to the broker of the charity. The charity gets it, but they don’t care (about capital gains) because they’re not a tax-paying entity.”
‘A HIGH QUALITY PROBLEM’
The focus on taxes can obscure a broader point: The long-time Medtronic shareholder facing a big tax bill also has seen gains on the stock.
In the hypothetical example, the investor with 1,000 Medtronic shares with a cost basis of 14 cents might indeed owe $20,000 in taxes related to the Covidien transaction. But the shareholder also will have earned $60,000 from the investment.
“This is a high quality problem,” Henneman said. “If you had bought Medtronic in 1973 at 14 cents, and it was now trading at 13 cents … you’d probably be even more upset.”
But Mairs & Power promotes a buy-and-hold philosophy, Henneman said, so that investors avoid short-term transaction costs and taxes to better build and maintain wealth in the long run. Given that perspective, the Covidien deal “is almost kind of an affront to us,” he said.
“Medtronic has to do what is in the best interest of all their shareholders, and we recognize that most shareholders are not going to have the long-term time horizon that we do,” Henneman said. “That being said, it hurt when they made that a taxable event.”
Dolores Rodenborg, the Eagan investor, said gifting her Medtronic shares to a nonprofit group isn’t an option because the stock’s dividends are an important source of income. And at 84, she doesn’t expect to be in it for the long-term. To pay taxes related to the Covidien deal, Rodenborg said she’ll likely have to sell about a third of her Medtronic shares.
That means less dividend income in her lifetime and fewer shares to pass on to her son when she dies. The tax implications are discouraging, Rodenborg said, but she offers a more optimistic assessment when explaining why she wants to maintain as many Medtronic shares as possible.
“I think, in the long run, that Medtronic will do better by this deal,” she said. “And in the long run, that will help my son.”
Christopher Snowbeck can be reached at 651-228-5479. Follow him at www.twitter.com/chrissnowbeck.
