A Pep Pill for American Home Products


By Gene Marcial Amid the stock market's turmoil, some big investors are "rediscovering" American Home Products (AHP), one of the more volatile stocks among the big pharmaceuticals. They expect some positive news that, finally, could help spur it to higher levels.

The Street has been generally down on AHP, which makes such such medicines as Advil, Premarin, and Robutussin, largely because its earnings have been under pressure. The lawsuits that have been filed against the company over its fen-phen diet-drug products are partly behind the financial squeeze. This year, AHP has had to add $950 million to its more than $12 billion reserve for litigation expenses for the diet drugs, which were withdrawn from the market in 1997.

Shares of American Home have been trading between 52 and 65 all year. But since the market fell to a low point after September 11 attacks, the stock has been rallying, climbing to 58.80 a share on Oct. 30 from 53.

RULE REVERSAL. One reason some investors have turned more positive: AHP expects to get a bonanza -- some $600 million to $700 million -- sometime soon because of a little publicized but hard-won victory over the IRS. A federal judge reversed on Oct. 5 an IRS decision claiming that AHP engaged in a tax scheme by using a Curacao partnership to shelter from taxes a capital gain of $605 million on the 1990 sale of its Boyle-Midway division for $1.25 billion.

U.S. District Court Judge Paul Friedman, as a result, has allowed American Home to claim a tax loss of $711 million, after his finding that the transactions by AHP's Curacao partner, Boca Investerings, had "economic substance" and weren't the shams that the IRS said they were. AHP and Boca "have satisfied their burden of proving by a preponderance of the evidence" that the IRS had "erred," ruled Friedman.

The IRS had claimed that the tax shelter, created by Merrill Lynch for AHP, had no business purpose but to avoid taxes. The judge's decision is Merrill Lynch's first victory in four court cases regarding tax shelters it had created 10 years ago for at least eight companies. The partnerships invested in debt securities in a way that reduced the companies' capital-gains taxes through financial deals with tax-exempt foreign entities. The IRS had been shutting down these shelters to curb potential tax abuses.

"IRRELEVANT." But in the case involving AHP and Boca, the court determined that their dealings involved real investment purposes -- and financial risks. Says Judge Friedman in his decision: "Since there was a legitimate partnership and legitimate business purpose, it is irrelevant if AHP was motivated in part...by a desire to reduce taxes."

Christopher Klieforth of the Washington law firm McDermott, Will & Emery, which represented American Home, says the court's verdict was "very significant" to U.S. corporations that legitimately embrace real risks in pursuing investment opportunities through tax-exempt foreign companies. This is the first time, he says, that a company was able to convincingly shed light on the complex issues surrounding tax shelters and their role in pursuing investment opportunities.

The bottom line for American Home: It will be refunded the $550 million it had put in escrow with the IRS, plus interest. That should help relieve some of the financial pain that AHP has been enduring -- and provide some spark for its stock. Marcial is BusinessWeek's Inside Wall Street columnist


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