Section 338(h)(10) Election on Lannett

In this article, I will discuss the tax benefit Lannett ("LCI") will receive from the Kremer Urban ("KUPI") acquisition.

Key Takeaways:
- Section 338(h)(10) can help LCI save tax by stepping up assets
- The NPV calculation shows $87 million cash tax savings
- The "election" may not happen yet

Let's begin.

#1) What is Section 338(h)(10) Election?
First of all, there's an awesome article on this topic from Tony Nitti.

Simply put, here is Section 388(h)(10) magic:
When a corporation purchases the stock of another corporation,  for tax purposes only the buyer is treated as acquiring the target’s assets.  

Or in other words:

A buyer could acquire a target’s stock for legal purposes - thereby keeping the target alive and preserving its non-transferable assets - but acquire the target’s assets for tax purposes, giving the buyer the stepped-up basis in the asset it seeks.

So in LCI's acquisition: LCI acquired KU's stocks -thereby keeping KUPI's contracts and patents - but acquired KU's assets for tax purposes, giving LCI the stepped-up basis in asset.

#2) How to calculate the tax benefit for LCI?
For the LCI-KUPI case, the bulkpart of asset step-up is in the form of  KUPI's intangible assets. There is $659 million net pro forma adjustment in intangible assets, $432 million of which will be amortized in 15 years.

(Source: LCI's 8K on Nov. '15)

So this amortization will hit LCI's bottom line in income statement, but in reality increase it's cash generating capacity.
We can do a simple calculation that discounts this 15-year amortization @8% discount rate, the NPV of tax saving is $87 million.
This number is lower than the management guidance, which expects at least $100 million tax benefit from Section 388(h)(10) election.

#3) Timeline for realization
It's worth mentioning that Buyer and Seller must jointly make the Section 338(h)(10) election no later than the 15th day of the 9th month beginning after the month in which the acquisition date occurs.

The acquisition completed on Nov. 2015, but I haven’t heard about the 388 (h)(10) election result yet.
Furthermore, Lannett has agreed to a 50/50 split of the additional tax liabilities UCB will incur associated with the section 338(h)(10) election, up to $35.0 million, and this $35 million has been recorded as liability.

I'm not sure that the $100 million management mentioned is the net number or not.

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