President Trump and Tax Cuts

By David Acharya, Partner at AGI Partners LLC and EVP of ACG New York

On April 26, 2017, President Donald Trump made his proposal for what is known as the “biggest tax cut” in U.S. history — with cuts that would benefit businesses and all income earners. This proposal will rival President Ronald Reagan and President John Kennedy tax cuts enacted in their respective administrations.

While the proposal affects all earners both individuals and businesses, I will focus on the effects of ACG NY’s community – middle market businesses.

Key Proposals affecting Middle Market businesses:

Reduction of Corporate Income Taxes

President Donald Trump’s plan to cut the tax rate to 15% for so-called pass-through businesses would be a significant change to the tax code (as opposed to current pass-through income taxed at an individual tax rate which can be as high as 39.6%).

This is aimed at small businesses, but pass-through treatment also applies to a lot of private equity funds as well as other funds (e.g., ones structured as LLC’s). Moreover, funds organized as limited partnerships likely would restructure to qualify as pass-through entities for tax purposes (or at least firms would be sure to raise the next one that way). In short, such fund managers could pay a flat 15% tax on all their income, including annual management fees on which they currently pay individual rates. This basically makes the carried interest debate irrelevant. The clear majority of middle market firms use pass-through structures.

I believe that lowering the tax rate for the business income of partnerships, S Corporations and limited-liability companies would spur U.S. business growth and job creation.

Reduction of Personal Income and Income Tax Brackets

President Donald Trump has proposed cutting Income Taxes from 7 brackets to 3 brackets. As part of the simplified brackets, Mr. Trump has also proposed doubling the standard deduction for individuals. That change would increase the deduction from the 2016 levels of $6,300 for single filers and $12,600 for married couples filing jointly. Doubling the deduction would greatly increase the number of people who take the standard deduction thus further simplifying tax returns going forward. Under the plan, deductions for mortgage interest and charitable contributions would be protected. The two deductions are among the most popular for individual U.S. taxpayers, making them two of the costliest for the federal government. Under current law, for 2017, the estate and gift-tax exemption is $5.49 million per individual. President Trump would repeal the estate tax entirely under his plan.

This will simplify tax planning for individuals and increased individual after-tax income which will then be used for spending on products/services and investments including retirements.

In addition, I believe that these breaks and estate tax exemptions will further increase the supply of middle market companies that are brought to market for sale. This will further increase the pipeline of investment opportunities for private equity funds.

Business Breaks and Interest Deductibility

President Trump has continued to express his support for writing off capital investments and to an extent, business interest deductibility. This will continue to encourage investing in businesses and infrastructure.  While there has been discussion on eliminating business interest deductibility, I believe this will not pass due to many industries having a powerful interest in seeing the business interest deductibility continuing.

The continuation of these breaks and deductibility is meant to create greater incentives for middle market firms to invest capital to grow their businesses.

Lower Capital Gains Tax

Under the plan, the top federal capital gains rate is cut from 23.8 percent to 20 percent. This is achieved by eliminating a 3.8 percent tax that is used to fund the Affordable Care Act.

The reduction is meant to create greater incentives for people to invest as well as improve the after-tax return of the sale of their businesses.

Implementing a Territorial Tax System

This area has not gotten as much press as other areas but I believe that global industrial and technology companies are among the companies pressing for President Trump’s proposal to implement a territorial tax system, in which the U.S. only taxes profits generated in the country, leaving overseas profits untouched except by those countries. Currently, the U.S. is unusual in taxing firms’ overseas profits if the proceeds are brought to the U.S., a system that has encouraged U.S. companies to book profits in low-tax foreign jurisdictions and leave them there. (Companies typically must pay the difference between what they already paid in foreign tax jurisdictions and the full U.S. tax bill for the repatriated profits.) In addition, it has introduced odd ways to manage cash such as leaving cash overseas and borrowing domestically (e.g. Apple Inc.).

About one in five companies in the Russell 1000 index (public companies including middle market) generate much of their sales outside the U.S., and more than half receive at least some revenue from abroad. U.S. firms hold about $2.6 trillion overseas, the nonpartisan congressional Joint Committee on Taxation estimates. A movement towards territorial system will eliminate a need for inversions or trapped cash.

The implementation has greater incentives for returning the capital to the US thus benefitting the US tax system and simplifying tax returns for middle market companies. The longer-term benefit for middle market companies is that the US system will have more capital to invest in smaller but growing business in a stronger US economy.

I believe that middle market businesses should continue to be bullish on President Trump’s tax proposal.

Spear Pharmaceuticals on the block through Moelis – sources

Provided exclusively by Mergermarket

Spear Pharmaceuticals, a privately held generic dermatology drug maker, has mandated Moelis to explore strategic options including a sale, according to two sources briefed on the matter.

Randolph, New Jersey-based Spear manufactures and sells prescription topical skin treatments for conditions including acne and actinic keratosis that are bioequivalent to branded products.

The company generated approximately USD 250m in revenue in 2016, one of the sources said. Its EBITDA could not be learned.

The sale process is at an early stage, having kicked off last month, one of the sources said.

Because anti-aging and skin rejuvenation treatments are popular in developed countries, Spear could command a high valuation, perhaps as much as 4x revenue, one sector advisor said.

Another sector advisor said a platform such as Spear’s would typically sell for an EBITDA multiple of between 10x-14x, a relatively rich multiple reflecting demand for such products. For high-growth companies, the EBITDA multiple could be higher, the advisor said.

Among Spear’s products are Fluorouracil Cream for keratoses, or lesions that develop from sun exposure over years, which it says is the generic equivalent to Valeant Pharmaceuticals [NYSE:VRX] Efudex Cream.

It also sells Tretinoin gel, a retinoid derived from Vitamin A to treat acne, which is the generic equivalent to Retin-A Micro, a widely used skin treatment sold by Ortho-McNeil Pharmaceuticals, a unit of Johnson & Johnson [NYSE:JNJ].

Spear representatives could not be reached for comment. A Moelis representative declined to comment.

by Yiqin Shen, Deborah Balshem and Dane Hamilton

As seen in the mergermarket newsletter on 02/04/2017

Rent The Runway talking to advisors about potential IPO, sources say

Provided exclusively by Mergermarket

Rent the Runway has held preliminary discussions with bankers about a potential initial public offering, said two sources briefed on the New York City-based apparel rental firm’s plans.

The company has been sounding out advisors about market conditions in anticipation of a listing, the two sources said. Ever since Snap’s [NYSE:SNAP] listing on 2 March, the frequency in which Rent the Runway and other consumer-facing tech companies have engaged bankers has increased, they said.

Rent the Runway has not yet picked bankers but if it were to bake off in the next couple of months, an IPO in the second half of the year would be possible or it could elect to wait until 2018, the sources said.

The company generated more than USD 100m in revenue in 2016 and it is profitable on an EBITDA basis, said the first source, echoing what CEO Jennifer Hyman told Recode in a 27 December report.

Rent The Runway allows women to rent designer apparel and accessories online. In addition to one-time rentals, the company rolled out an “unlimited” service a year ago in which customers pay USD 139 a month to rent out top fashions on an ongoing basis. It also operates brick-and-mortar stores in six major US cities and it has partnered with luxury retailer Neiman Marcus to open “stores within a store.”

In December, the fashion technology startup raised USD 60m in equity financing led by Fidelity with participation from investors such as Bain Capital, Technology Crossover Ventures, Highland Capital, and Advance Publications. It has raised approximately USD 190m in private capital since it was founded in 2009.

Co-founders Jennifer Fleiss and Jennifer Hyman reportedly each own 13% stakes in the company.

Rent The Runway competes with other online apparel startups such as Le Tote and Stitch Fix.

The company did not return a message seeking comment.

by Troy Hooper in San Francisco

As seen in the mergermarket newsletter on 06/04/2017

The Real Cost of Fast Fashion

Provided exclusively by The Street

With traditional retail prices dropping, you’re better off with an elevated brand.

Unless you’ve been living under a rock, you’ve inevitably noticed that retail prices are dropping faster than you can say “highly flammable polyester blend.”   Oversaturation in the retail market, Millennials spending more on experiences than material possessions and a steep decrease of in-store traffic all snowballed into the winter of retail discontent. TheStreet‘s Lindsay Rittenhouse also noted that heightened competition from e-commerce players such as Amazon ( AMZN) , elevated rent costs and rising interest rates are expected to tack on an additional headache for retailers.  The disconnect between fast fashion and traditional brands has also created a rift, with retail trying to catch up to fast fashion with Sisyphean results. No matter how hard they try, the traditional retail structure can’t keep up with fast fashion’s culture, cost of goods and supply chain noted Adheer Bahulkar, a partner in the consumer goods and retail practice at management consulting firm A.T. Kearney during a phone call to TheStreet. Bahulkar also noted that traditional brands need to go back to creating stories that resonate with their community rather than trying to keep up with the latest de rigueur look, because they end up alienating their current customer and eschewing better quality in favor of quicker output.   With that being said, traditional retail has had to cut the price of clothing to such a degree to remain competitive that you’re better off purchasing from such retailers anyway. The item (usually) won’t self-destruct after a few washes, you’ll probably keep the item longer because you respect the brand more and the piece may have a longer life because you’re more likely to donate rather than toss it.


“Fast fashion is dependent on high volume,” said Nanette Heide, ACG New York board member and partner at Duane Morris. ” As the consumer becomes more conscious, they may be moving away from impulse purchases of garments that are made to be off trend the moment they are placed in a shopping bag.”

To prove this point that traditional retail is the incontestable better value, let’s look at the prices of a “control top” (not Spanx) of a popular women’s style currently available from essentially every brand.

Off-the-shoulder or “cold shoulder tops” (as a former fashion copywriter, I can attest to the fact that this is a cop out) are having a moment, no matter how impractical they are for undergarments and ill-suited for a corporate environment. Because they’ve been around for several seasons more conventional retailers in addition to fast fashion have embraced them and bare shoulders have become a core seasonal style statement for spring collections. What really differs by brand is the price and construction, and if it’s machine washable.   Let’s see how the prices stack up against one another in order of most to least expensive at the time of publication. The lack of disparity between pricing/more expensive brands versus quality may surprise you.

As seen in The Street on 03/30/2017

Xerox targeting USD 100m for M&A

Provided exclusively by Mergermarket

Xerox [NYSE:XRX], the Norwalk, Connecticut-based document technology and outsourcing company, could spend around USD 100m on acquisitions, according to CFO William Osbourn.

On Tuesday’s 4Q16 earnings call, the CFO noted that Xerox expected to have between USD 1bn and USD 1.2bn in cash available for capital allocation, with USD 300m anticipated for debt repayment, USD 280m in dividends and approximately USD 175m for capital expenditures.

“And we are currently targeting approximately USD 100m for M&A, which leaves somewhere between USD 145m and USD 345m to be deployed opportunistically and according to our capital allocation priorities,” he said.

A presentation slide stated opportunistic uses included debt repayment, M&A and pension contributions.

Osbourn noted that Xerox had a number of dynamics to cover in terms of its capital structure following the spin-off of Conduent [NYSE:CNDT]. He explained that Xerox needed to carry less core debt as a smaller and less diversified company and had lowered its total debt to keep its core leverage within the target range, giving it more financial flexibility.

In his prepared remarks, CEO Jeff Jacobson noted that Xerox had completed the spin-off of Conduent, its business process outsourcing (BPO) operation, on 31 December 2016.

In the Q&A session, JPMorgan analyst Paul Coster asked about the M&A criteria.

“Our acquisitions will be in areas that we are clearly experienced with, that are close to our knitting. Areas that we understand,” Osbourn replied.

The CFO named the global imaging services area as historically of interest, noting that Xerox typically bought multi-branded resellers and converted them into its own brand. He said this had previously generated very good returns.

“We have paid a multiple in the range of one times revenue and we look, to the extent that they are the right opportunities in doing those types of acquisitions in 2017 and beyond, not only in the US but internationally,” he continued.

Osbourn said the company would likely pay a higher multiple for acquisitions in the workflow automation and software technology spaces, depending upon the specifics of the potential transaction.

CEO Jacobson added that Xerox was looking for targets that would allow the company entry into markets it couldn’t currently address well. As an example, he said production color was a USD 5bn market growing at 5% and it would help Xerox a great deal to have technologies in the commercial offset print and packaging market within that area.

Xerox announced in January 2016 that as a result of a review of the company’s portfolio and capital allocation options announced in October 2015, the board had approved a plan to separate Xerox into two independent publicly traded companies. The BPO company, which had approximately USD 7bn in 2015 revenue, was split-off and named Conduent, while the document technology company, with 2015 revenue of around USD 11bn, remained as Xerox.

Having been a prolific acquirer for over a decade, Xerox’s M&A efforts have been quieter since the review was announced in 2015. Its only notable buy since this time was the March 2016 acquisition of Imagetek Office Systems, an Arlington, Texas-based full service document solutions and service provider, for an undisclosed sum.

While the majority of Xerox’s acquisitions have been of US-based assets, it has also been active in Europe and Canada. In-country law firms Fasken Martineau Dumoulin and Osborne Clarke have been used in Canada and the UK, respectively. UK-based firms have also advised on multiple deals in continental Europe, according to the Mergermarket M&A database.

Financial advisory matters are typically handled in-house, although JPMorgan and Blackstone Advisory Partners were used on its largest deal in the past decade. The latter has also advised on the sell side.

Lazard and Goldman Sachs served as financial advisors and Cravath, Swaine & Moore as legal advisor to Xerox on the business separation. Centerview Partners and Paul, Weiss, Rifkind, Wharton & Garrison advised the board.

Xerox reported a cash balance at year end of USD 2.2bn and debt of USD 6.3bn. The company has a market capitalization of USD 7.1bn.

As seen in the mergermarket newsletter on 02/02/2017

Pfizer mulls sale of treatment portfolio worth USD 2bn, JP Morgan advising – report

Provided exclusively by Mergermarket

Pfizer (NYSE: PFE), the drug maker based in New York, is considering selling multiple drugs for cardiology, urology, and beyond with the help of JP Morgan as advisor, according to a newswire report.

The Bloomberg item, citing people familiar with the matter, said the potential divestitures could fetch up to USD 2bn from a buyer and that the company’s preference would be to sell the treatments as a single portfolio.

The report credited the people with stating that the products could appeal to either private equity firms or drugmakers, and that their combined revenue of USD 700m is 40% derived from US sales and 45% from sales in Europe.

Both Pfizer and JPMorgan declined to comment.

As seen in the mergermarket newsletter on 02/02/2017


1 2016 was a substantial year for M&A industry: According to Pitchbook, PEs and VCs saw an enormous amount of fundraising and dry powder during 2016. Global dry powder in 2016 was at an all-time high of about $754bn and the average PE fund size increased over 6% to $765mn, while the median fund size increased to a decade high of $280mn. ~88% of PE funds hit their capital raising targets, which is the highest rate ever recorded. The M&A market, in general, is very cyclical in nature and is currently at one of its peaks. Despite that, some funds prefer to move downstream to find less expensive deals at smaller companies, yet the indicators show that funds with commitments under $100mn form a small part of the market space. Median EV/EBITDA multiple jumped to 11.0x for M&A transactions in the USA, partially driven by competition amongst strategic acquirers and PE firms. Add-ons made up 64% of the buyout activity last year, which is one of the highest levels ever recorded. With respect to deal closure time, it took on an average of 6 months to close a deal across multiple sectors.
2 High capital flow in Insurance Sector: Multiples are at an all-time high with TAG Financial selling an agency in 2016 for 12.0x EBITDA up from ~6.0-7.0x in 2012. Pure acquisition strategies of insurance brokerages, especially in the Property & Casualty (P&C) sector, are progressing because 92% of people renew their insurance over and over again. Obamacare alternatives were growing, but now have difficulty retaining growth  in Trump’s administration, while self-funded plans are experiencing a rise. There are capital requirements for insurance carriers driven by the lack of regulatory capital, leading to high capital flows in P&C and Reinsurance sub-sectors. The M&A activities will continue to grow in in 2017, given the volatility in the sector.
3 Solid Waste Sector has a high degree of optimism for 2017: In 2016, the industry had about $50bn of annual revenue. In this business, there are three big players that control 45% of the market: Waste Management, Republic, and Waste Connections. About 35% of the market belongs to privately owned companies and the balance 20% is municipal. Solid waste companies are valued at about 8.5x EBITDA as compared to 6.5x two years ago. The Hazardous Waste business had $7bn of activity in 2016. Two major companies in this sector are Clean Harbors and US Ecology. Hazards and industrial waste are a strong part of new Environmental Protection Agency regulations. “One of the reasons for regulations is that a lot of owners of the privately-owned companies are second-generation wealthy people who want to retire and whose kids don’t have an interest in the sector,” said John Quirk of Cronus Partners LLC. Even public utilities and old non-functioning power plants need to be cleaned up and cost a few million dollars. Back in 2008, TVA Kingston Fossil Plant in Tennessee had a spill, which cost them between $675mn and $975mn. There is a lot of activity in this sector and the global factors don’t affect the industry much. A lot of $50mn deals are coming out this year. Growing regulatory complexity and aging infrastructure will continue to drive the demand for these services.
4 PE acquirers are competing aggressively for consumer space: Dollar Shave Club was acquired for $1bn by Unilever and IT Cosmetics for $1.2bn by L’Oreal. These companies are relatively young and are yet to return profits. PE companies are very aggressive in competing with its strategic counterparts. A high-growth brand’s valuations are often based on revenue as supposed to EBITDA. Previously in the grocery store, finding the next brand, good shelf space, and center aisle was the main focus, while today, the brands around on the perimeter of the grocery store are the assets to look out for. Traditional retailers are eying technology companies to improve their in-store experience and value proposition. Increased focus on health and wellness is expected to fuel activity in the Food & Beverage sub-sector.
5 The Technology Sector has a lot of new entrants: The valuations for this sector are based on Revenue multiple as opposed to EBITDA. The biggest deal last year was the acquisition of Cvent by Vista Equity Partners for 7.1x Revenue. Software, as a sector, has a Revenue multiple of 4.0x. There is a scarcity in the supply chain in terms of selling companies in other sectors–a lot are shifting to tech. The strategic acquirers are buying innovative companies in the sector. There are two phases for the M&A activity in the technology sector: (1) A lot of money was invested into Cloud, SaaS and mobile three to five years ago, and the mature companies are now being sold. (2) New sectors like Artificial Intelligence, Virtual Reality, Analytics and Network Security are emerging where the capital is employed and will be harvested in next two to three years. Currently, Artificial Intelligence is the best bet in this sector.