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Deloitte’s survey of life sciences CFOs reveals that many biopharma and medtech companies are planning to strategically invest in R&D, business operations, and capital projects in response to US tax reform.
One goal of the new law commonly referred to as the Tax Cuts and Jobs Act (TCJA), which was signed into law on December 22, 2017, is to increase domestic business investment and thereby create more jobs in the United States. One anticipated expectation of the bill was that companies would reinvest money into areas that will help the US economy grow. The Congressional Budget Office (CBO) predicted that “the act’s effects on the US economy over the 2018–2028 period will include high levels of investment, employment, and gross domestic product.”1
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Deloitte’s survey of biopharma and medtech chief financial officers (CFOs) reveals that the majority of companies surveyed are interested in investing in research and development (R&D), business operations, and capital projects, some of them in the United States. This finding may surprise market speculators who predicted that biopharma companies would primarily invest financial gains in share buybacks or mergers and acquisitions (M&A).2 That said, most CFOs surveyed do not expect the law to have a major impact on their hiring or compensation plans.
The TCJA is just one issue that CFOs are dealing with as policymakers change international tax laws and trade agreements and ramp up rhetoric on curtailing drug price increases. In the meantime, many companies are working to understand financial reporting requirements and investing in enterprise resource planning (ERP) systems and analytics to meet the tax reform law’s requirements.
Six months after the president signed the TCJA, many life sciences CFOs are still assessing its impact on their organizations. Seventy-eight percent expect to benefit from the law, though they differ on when the benefits will take effect; they are about equally split between the coming fiscal year, the mid-term, and five or more years later (see figure 1). Some expect multiyear benefits.
Although many respondents expect their effective tax rates to either go up or stay the same in 2018 and 2025, the benefits from the law come from other provisions, such as the ability to repatriate overseas cash after a one-time “transition tax.”
The Deloitte Center for Health Solutions, along with Forbes Insights, surveyed CFOs of biopharma and medtech companies in summer 2018. The objective was to understand how biopharma and medtech companies were strategically preparing for and responding to tax reform.
CFOs reported that they are most concerned about the global intangible low taxed income (GILTI) and base erosion anti-abuse tax (BEAT) provisions:
CFOs surveyed are split when it comes to being prepared to benefit from tax reform: 45 percent are confident they are doing everything they can to capitalize on the new law; 45 percent are still working to understand the implications; 10 percent say they will need to make significant investments to be able to capitalize on tax reform.
It is likely we will still see positive impacts from the law. — Surveyed CFO
We will utilize the wait-and-see approach to see how things evolve and then we can make any further decisions. — Surveyed CFO
Survey results show that a greater percentage of CFOs are likely to invest in activities intended to grow their business rather than in share buybacks or M&A. Most companies plan to invest in R&D (65 percent), followed by general business operations (55 percent) and capital projects (50 percent). Share buybacks and M&A ranked fifth and sixth (see figure 2).
Even fewer companies selected increasing compensation and hiring new talent—areas that tax reform supporters hoped to impact—as likely investments. That said, investment in R&D, business operations, and capital projects may result in more or different jobs. For example, of the respondents likely to invest in business operations, 88 percent indicated that analytics and automation are likely targets. While some companies may be planning to automate tasks and increase efficiencies by using data, they may also need to hire new talent to help leverage new technology to achieve these goals.
While both biopharma and medtech companies are most likely to invest in R&D, they differ in the ranking of their next likely areas of investment: Biopharma is likely to focus on capital projects and medtech on business operations (see table 1).
Surveyed CFOs expect most of their spending to occur within the next year. In the short term, CFOs plan to focus on business operations and charity. They reported that they are most likely to make debt repayment, capital project, and M&A decisions in the longer term (three years or more). This aligns with the Congressional Budget Office’s projections that the economic impact of the law will be greatest between 2018 and 2023 and soften after 2025.4
When asked whether the ability to expense fixed assets in the United States would affect companies’ approach to capital investments, 62 percent of CFOs responded that they expect to accelerate their capital investments in response. This is another indicator that the law may increase domestic investment.
The 10K filings and earnings transcripts of the 10 largest biopharma and 10 largest medtech companies based in the United States give some indication as to how they plan to invest their financial gains from the tax law (see figure 3). Capital projects, share buybacks, and dividends are high on the list. Business operations and R&D were not publicly reported, however, and therefore, are not included in the figure below.
While only 42 percent of surveyed CFOs stated they would likely invest financial gains from tax reform in M&A, 66 percent nevertheless expect increased M&A activity because of tax reform. This may be because of a combination of financial gains, reduced uncertainty around tax policy, and targets becoming more attractive. Biopharma companies are more likely than medtech companies to invest in M&A.
During the 2016 election and tax reform discussions in 2017, many life sciences companies postponed M&A decisions. With the passage of the reform, M&A activity picked up in the first half of 2018 compared to the same period in 2017. The deals are also larger. In the first half of 2018, M&A deals worth approximately US$141 billion were announced; during the same period in 2017, they amounted to approximately US$105.5 Notable US deals announced during the first half of 2018 include Sanofi’s acquisition of Bioverativ for US$11.6 billion,6 Celgene acquiring Impact Biosciences and Juno Therapeutics for up to US$7 billion and US$9 billion, respectively,7 and Novartis acquiring AveXis for US$8.7 billion.8
Of the CFOs expecting an increase in M&A investment, 38 percent believe that tax reform will change how they calculate target valuations, whereas 28 percent feel valuations will remain the same. Valuations may be impacted as a result of changes in the corporate tax rate, as well as how tax attributes of the buyer and target may fit together. For instance, tax reform caps the net operating losses (NOLs) at 80 percent of taxable income and such losses cannot be carried back to earlier years. Although NOLs can be carried forward indefinitely, the value of future and previous NOLs will be reduced as a result of the lower corporate tax rate. All these factors will have an impact on target valuation.9
One of the stated goals of the tax reform was to encourage US domestic investment. Surveyed CFOs stated that they were significantly or somewhat more likely to develop new research facilities (68 percent), locate new intellectual property (57 percent), and build new manufacturing facilities (48 percent) in the United States because of tax reform (see figures 4, 5, and 6). Whether these considerations will be acted upon and result in material investments remains to be seen, but many CFOs are weighing their options.
With regard to impact on R&D, despite a decreased net tax credit for research on rare diseases (the new bill reduces the tax rate for research on rare diseases, known as the Orphan Drug Credit, from 50 percent to 25 percent), 50 percent of surveyed biopharma CFOs plan to increase investments in rare disease/orphan drug R&D, and another 40 percent expect no change. Possibly, other market and regulatory incentives and the intrinsic clinical importance of these research areas are keeping companies focused on these areas despite the modified tax implications.
CFOs surveyed report that the new tax law has a greater impact on supply chain processes than on manufacturing operations, particularly on logistics and distribution (67 percent), followed by sourcing and procurement (50 percent), supply chain planning (47 percent), and manufacturing (37 percent). In building their supply chain models, many life sciences companies have taken tax considerations into account, and any changes to tax law, as in the current case, necessitate a review of these models. A company’s supply chain, including the location of intellectual property, facilities, sourcing, production, and inventory management, are typically significant contributing factors to a company’s effective tax rate. Supply chain structures designed years ago for competitive advantage and operational and tax efficiency may need to be reevaluated in light of domestic tax reform as well as continued tax reform initiatives around the globe.
Many CFOs are closely monitoring US tax reform along with other global tax and policy changes. Forty-five percent of surveyed CFOs are adopting a “wait and see” approach, as they believe the law is still evolving (27 percent) or they are questioning the permanence of tax reform (18 percent). The remaining 55 percent see the tax law as one of many new global requirements that they will need to prepare for and allocate resources to in the interest of long-term strategy.
The OECD’s Base Erosion and Profit Shifting (BEPS) initiative, which is currently under review by over a hundred countries,10 and other non-US fiscal legislation and policy are the main issues influencing surveyed CFOs’ business strategies. The US administration’s proposed trade measures and health and tax reforms are the next most important issues.
Operating under so much uncertainty can elevate the importance of strategic risk management. Company executives should identify all the strategic risks, model potential scenarios, and estimate the relative impact of each one. Executives should engage strategic decision-makers to prepare for potential scenarios. Global uncertainty is unlikely to go away, and companies should systematically plan for and track organizational risks to analyze and interpret how they relate to their strategy.
Many CFOs are also taking stock of their organization’s current capabilities to prepare for tax reform. US tax reform presents opportunities to newly establish or improve internal processes and capabilities. 57 percent of respondents want to improve their understanding of financial reporting requirements, 45 percent want to better understand the larger impacts of tax, and 42 percent want to better meet tax reporting requirements.
Many CFOs are also looking at investing in internal IT infrastructure and hiring professionals in order to comply with US tax reform. The majority of companies (58 percent) want to invest in ERP systems to meet the data requirements of the new tax law and 55 percent are planning to increase the use of data analytics to tackle tax reform.
We need real-time, data-driven insights to make tax-related decisions and to move forward. — Surveyed CFO
Many biopharma CFOs are focused on modeling new tax provisions for tax planning; many medtech companies are focused on increasing the use of data analytics for reporting.
When it comes to development of technology, many biopharma companies are looking to build internal IT infrastructure to comply with tax reform while medtech companies are more likely to seek help from third-party vendors and depend on external IT infrastructure.
This survey provides insights into current biopharma and medtech CFO reactions to US tax reform. Yet the majority of companies are still evaluating their strategic decisions and financial investments. US tax reform represents a significant policy change, and along with other major global tax, trade, and health care reforms, could drive a shift in industry dynamics. For example, a lower corporate tax rate could make the United States a more attractive investment destination, but changes to trade policy could impact the relative attractiveness of other geographic markets. An increase in M&A activity, expected by 66 percent of surveyed CFOs, could change the industry’s competitive balance and structure. CFOs should consider multifaceted variables and uncertainties when deciding on where to invest in the future.
While US tax reform will not impact all companies in the same manner, all organizations will likely face some level of strategic uncertainty. Deloitte believes that tax policies enacted in TCJA are not “one and done.” The tax law will continue to evolve in an ever-changing process that companies will need to prepare for in advance. Thus, CFOs may want to consider the following actions as they execute strategic plans in light of US tax reform and future changes: