Since I've Been Comparing Merck To Apple -- On Repatriation -- Here Is (Apple CEO) Tim Cook's Testimony, For Capitol Hill, This Week

UPDATED: 6:05 PM CDT | 05.20.13 -- The New York Times now has released its piece on all of this, online -- and Apple's Time Cook gets excoriated in it -- for some of the hyperbole in his 17 pages, below. In my estimation, it is only a matter of time before the Times catches up to Merck and Pfizer. And possibly Congress will, too. [End, updated portion.]

At some point tomorrow, I'll get around to explaining the ways in which Apple's corporate structure, and use of CFCs, or controlled-foreign-corporations, differs from Merck's approach. [Hint: It primarily involves the transfers of intellectual property, to generate more income in tax haven jurisdictions -- in Merck's case.] But for now, you may safely assume that -- in the main -- they are largely similar. At least similar enough to make it worthwhile to watch what Apple does -- on foreign cash repatriation, as a "canary in the coal-mine" -- for what Merck might do.

And so, here is the advance-copy (that is some 17 pages of PDF goodness!) of Mr. Cook's upcoming testimony before Congress -- on Apple's recent $17 billion debt issuances, its unimaginably large $60 billion stock buyback program. . . . all of which drives his call for reform of the United States corporate tax code (which, he argues, makes most of these complex financial machinations necessary).

Having said all of that, though -- Apple does pay an immense amount of US corporate income tax. Mr. Cook estimates that Apple is responsible for almost $1 of every $40 the US Treasury collects, in corporate income taxes, from all corporate taxpayers -- paying more than $6 billion in federal taxes in 2012 (which, to be fair, of course -- may just mean that companies like Merck and Pfizer aren't paying their fair share). Wow. Apple's effective 30.5 per cent federal income tax rate here in the US is much higher than Merck's (which stood at 27.9 per cent at year end 2012, but was around 11 per cent in 2011) -- and dwarfes Merck's 2012 $2.44 billion in tax payments, on a dollar for dollar basis.

. . . .Apple, a California company, employs tens of thousands of Americans, creates revolutionary products that improve the lives of tens of millions of Americans, and pays billions of dollars annually to the US Treasury in corporate income and payroll taxes. Apple’s shareholders – from individuals and institutions to pension funds and public employee retirement systems – have benefitted from the Company’s success through the appreciation of its stock price and generous dividends. Apple safeguards the capital entrusted to it by its shareholders with prudent management that reflects the Company’s extensive international operations. Apple complies fully with both the laws and spirit of the laws. And Apple pays all its required taxes, both in this country and abroad. . . .

More tomorrow. And by the way, Merck CFO Kellogg did talk about why he did the aggregate of $6.5 billion debt deals last week, and why the $16.5 billion stock buy-back is happening now, at Merck -- but didn't even remotely hint at repatriation, in his UBS talk today, in Manhattan. And he didn't mention the underwriters' conflict of interest -- even though Merck did a much more complete job of disclosing it, under FINRA Rule 5121, than Apple did -- in its similar definitive 424(b) debt prospectus, of early May.

2013 Thesis: Merck's Stock Is Almost Certain To Rise -- Through At Least The End Of Year

There will be dips, and there is always the remote possibility of some vast disaster hitting Merck's sales line in 2013. That much must be said at the outset. But it would have to be a more than 10 per cent real decline, to matter this year¹. Why? Well, because Merck is pulling some non-operating financial levers, and very adroitly so, at the moment.

In sum, I'll conservatively predict an overall three to six per cent Merck NYSE stock price increase, net of everything else, by year end 2013. This will be true, I predict, even if not all its expected 2013 "in the pipeline" FDA approvals materialize.

With all the financial engineering now being laid into Merck's second half of 2013, it is hard to see how the stock won't -- in general -- rise more often (and in greater amplitudes) than it sinks. It is likely that some $10 billion worth of Merck's common stock will go back into its treasury account during 2013, decreasing outstandings. It is also highly likely that Merck will bring home a like amount of cash, from overseas, at near-nil tax rates, and thus pay off most of the debt it issued last week. [Of course, not one for one (many of the trauches are multi-year) -- but the cash returned is fungible, and will decrease interest expense -- and soon.] Thus, every penny it doesn't spend on taxes (for repatriating dividends) will fall right to the EPS line, and be levered with a debt reduction effect.

And that EPS line will garner the benefit of a smaller denominator -- over 12 per cent fewer outstanding shares over the life of the buyback, which will concentrate Merck's reported earnings over a smaller base of shares. This EPS levering will begin slowly, as the share equivalents are counted on 360 days outstanding as a linear average, in a year -- but the share count will drop significantly in the back half of 2013, if Merck gets started repurchasing shortly. [And remember, Merck's dividend is nearly a riskless almost four per cent cash return, every year, on each share.]

Now, on top of all of that (the factors within Merck's control), we will see an "out of Merck's control" knock-on effect. That knock on effect will appear, as many of the investment banking houses (through their buy side analysts) shortly start increasing their 12 month targets, for Merck's NYSE stock price, even if sales of Januvia^® remain fairly underwhelming through all of 2013. They will do so, because they know that the above financial structuring steps will net, net actually increase Merck's unrestricted cash flows, by year end (and very tax efficiently so), and in perpetuity. UPDATED: Here is a list of bankers, from which I'd expect we will see increased 12 month NYSE price targets -- as each of them were underwriters of Merck's debt last week, and each of them undoubtedly have clients holding Merck stock, even if the smallest among them don't hold Merck stock directly as a firm. The names cover all of Wall and Broad: BNP PARIBAS, Deutsche Bank Securities, J.P. Morgan, Morgan Stanley, BofA, Merrill Lynch, Citigroup, Credit Suisse, Goldman, Sachs & Co., HSBC, RBS, UBS Investment Bank, Drexel Hamilton, Santander, SOCIETE GENERALE, Standard Chartered Bank, SMBC Nikko, US Bancorp, Wells Fargo Securities and The Williams Capital Group, L.P. [End, updated portion.]

Afterall, even if Merck pays somewhat higher prices, on the NYSE, for these repurchased shares (due in part to the conflicted interests the investment bankers now have -- to get their Merck shares, and those of their clients, repurchased at marginally higher prices) -- Merck's tax benefit will very likely still outstrip the increase in Merck's NYSE quoted price per share. That is, I don't expect that Merck's NYSE price will increase by more than the tax rates -- on a percentage basis -- had Merck repatriated the same amount of offshore cash, using a strategy that required Merck to pay "full-freight" federal income taxes.

In short, the (would-be) Masters of the Universe on Wall Street are lining up, all with powerful incentives to drive Merck's stock price north -- almost without regard to how Merck's operating business fundamentals pan out in the back half of 2013. So, even a slightly better than expected performance from any of the operating businesses, in 2013, will magnify the effect of all the above financial manuevering.

My advice? Do not go short on Merck in the rest of 2013 -- or buy puts -- unless you plan to buy and hold a multi-year position.

The scenarios for sustained NYSE price declines, at Merck -- are all but evaporating, even if currencies take another 7 or 8 per cent from the global sales line -- by year end. You've been warned. Know that Merck's stock is over 75 per cent held by large institutional investors, and they've figured all of this out, as well. They will sell a little, as the stock rises, and buy a little more, if the stock dips. This is essentially a downside protection structure for Merck's common stock.

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1. I expect the same effects will appear at Apple in 2013 through 2014 -- only in even larger proportions -- as its benefits from the same strategies will be proportionately-larger, than Merck's. Just FYI -- of course, do your own diligence here -- but know that I've been a bear on Merck for quite a while. For 2013, I am now a bull.</sup>