Decreasing Our Fair Value on Caterpillar

We have decreased our fair value estimate for

The potential valuation impact is uncertain, but we now assess the taxes and penalties we believe the firm is likely to owe. We suspect the core of the matter is not “new” news, but rather that it relates to the risk already disclosed in 2014-16 10-Ks. The 95-page April 2014 report “Caterpillar’s Offshore Tax Strategy” by the Permanent Subcommittee on Investigations, U.S. Senate, concluded that Caterpillar used parts sales to shift profits from the high-tax-rate U.S. to low-tax-rate Switzerland, thereby cutting U.S. taxes by $2.4 billion between 2000 and 2012. The Senate report followed a whistleblower lawsuit by a demoted employee, which discovered evidence used in subsequent investigations.

The IRS proposes to tax as U.S. profits the amount earned from parts transactions by Caterpillar SARL in 2007-12, and the firm is contesting tax and penalties of around $2 billion for these years. However, because it has continued to file tax returns on this same basis, we believe the current exposure could be $3 billion, and we thus deduct this from our estimated fair value for all equity shares. Future tax rates could be greater if this Swiss segment continued to sell most international parts, given the mid-single-digit tax rate the firm enjoys on that operation. As a potential offset to this this, we expect the overall statutory rate is likely to decline beginning in 2018 if President Donald Trump can muster sufficient support for his corporate tax reduction initiative. We’re maintaining our corporate tax rate at this time.

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