The recent popularity of tax inversion strategies got me to thinking about what might be the toughest thing to do when analyzing a company. Namely determining what its optimal capital and tax structure could be. Most of the time, I tend to rely more on free cash flow analysis than trying to forecast capital structure or determine optimal tax considerations. I figure if I develop a reasonable and attainable cash flow forecast it would be easier to determine what the use of that cash might be. Even then I tended to be off in my cash use prediction because of the Curse of the Financial Analyst—we think tend to think every business decision is a financial decision. More often than not many other business and management considerations are of equal, if not higher, importance. We as analysts often forget that.
For example, why don’t more companies take advantage of tax inversion strategies? Management might feel uncomfortable having essentially two headquarters, one for executive management and one for day to day operations—some managements may feel uncomfortable managing crucial functions remotely. Some might feel that tax advantages and loopholes can shift over time for a variety of reasons, meaning a company may have to move its headquarters more than once to keep their tax saving strategy intact (e.g. Accenture moved to Ireland from Bermuda due to changes in tax considerations). Additionally some companies might see longer term opportunities for that cash that could offer a better return, even after taxes. This might include investments in research and development, marketing and distribution, new capacity, acquisitions, and the like. It also depends on where the cash resides and the opportunities, or lack thereof, there might be in that market.
Still as shareholders we often want as much cash returned to us from our investments as quickly as possible, and managements need to respect the will of its owners when it makes sense to do so over the long run. It really comes down in my view where the management and investors believe the company is in its growth cycle. If it is early on in the cycle I would rather see cash spent on growth, which also lowers a company’s tax bill without adding more managerial complexity to the organization. If the company is in a more mature industry I would rather see the company managed for cash flow and see that money returned to investors. Therefore in reality, I think that we need to take as close of a look at the personality and management style of its executive team and determine if their longer term goals match where we think the company is in its growth cycle as much as we do trying to determine what companies may be best suited for a change in capital or tax structure on a pure numbers basis.