Biggest pharma combo becomes biggest bust

Rule changes by Treasury Department mean trouble for any U.S. companies attempting inversion deals in near term

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NEW YORK & DUBLIN—Whether or not it was the intent of the U.S. Department of Treasury to scuttle the intended merger plans between Pfizer Inc. and Allergan plc with new rules about inversion deals—and, let’s be honest, that was likely a big goal of the Treasury Department—the deal is indeed now a dead one. It could also mean the death of hopes for other companies who want to do inversions, at least for some time until enterprising folks find the right loopholes.
We already reported the fact of the “Pfizergan” demise in our article “Pfizer ends plans to merge with Allergan,” noting that, first off, Pfizer and Allergan had planned to become the biggest phama of them all in a $160-billion merger and acquisition (M&A) deal that would, in part, have allowed U.S.-based Pfizer to reduce its tax burden by re-domiciling in Ireland. Instead, Pfizer ultimately called off the deal and gave Allergan $150 million to help pay for the Irish company's expenses and trouble.
The second big thing we noted in that article was that the Treasury Department had twice made rule changes for M&As that failed to dissuade Pfizer and Allergan and then, finally, on April 4, the Treasury Department and the U.S. Internal Revenue Service managed to spur Pfizer to kill the M&A plans when they issued temporary and proposed regulations to further reduce the benefits of and limit the number of corporate tax inversions, in part by addressing what is called earnings stripping.
As U.S. Treasury Secretary Jacob J. Lew said in the April 4 news release about those newest of the anti-inversion rules: “Treasury has taken action twice to make it harder for companies to invert. These actions took away some of the economic benefits of inverting and helped slow the pace of these transactions, but we know companies will continue to seek new and creative ways to relocate their tax residence to avoid paying taxes here at home.
“Today, we are announcing additional actions to further rein in inversions and reduce the ability of companies to avoid taxes through earnings stripping. This will have an important effect, but we cannot stop these transactions without new legislation. I urge Congress to move forward with anti-inversion legislation this year. Ultimately, the best way to address inversions is to reform our business tax system, which is why Treasury is releasing an updated framework on business tax reform, outlining the administration’s proposals to date as a guide for future reform. While that work goes on, Congress should not wait to act as inversions continue to erode our tax base.”
So what does this mean for Allergan, Pfizer and the wider range of companies out there considering M&As?
Well, Allergan held a conference call to discuss its strategy and maintained that its growth profile is the same as it ever was. So, as Arpita Dutt pointed out in a Zacks Investment Research note shortly after the deal collapsed, the company—which has about 70 mid- to late-stage programs in its pipeline—will continue focusing on driving sales of products like Botox, Restasis, Viibryd, Linzess and others, and it will continue to research and develop new products like Viberzi, Kybella, Vraylar and Dalvance to drive long-term growth.
“The company also has the divestiture of its generics business to Teva Pharmaceutical Industries Limited coming up in a deal slated to close in June,” Dutt noted. “The after-tax cash and equity proceeds of $36 billion from the Teva transaction can be used by Allergan to pay down debt or pursue business deals or to buy back shares.”
As for Pfizer, speculations about the company pursuing other non-U.S. based companies had already begun while the ashes of the Pfizergan deal were still smoldering. And, as Dutt wrote, “at one point of time, Pfizer had failed in its efforts to acquire AstraZeneca. Currently, names of other U.K.-based firms like GlaxoSmithKline plc are being considered as being on Pfizer’s radar. In addition to a desire to lower its tax rate, Pfizer needs to boost its product portfolio as well as pipeline.”
Also, still of interest to investors in Pfizer is the actual future shape of the Big Pharma itself, irrespective of any M&As. As Ian Read, chairman and CEO of Pfizer, said recently, “We [still] plan to make a decision about whether to pursue a potential separation of our innovative and established businesses by no later than the end of 2016, consistent with our original timeframe for the decision prior to the announcement of the potential Allergan transaction. As always, we remain committed to enhancing shareholder value.”
And that might mean an end for now to looking for M&A deals that would reduce taxes, speculated Sanford C. Bernstein & Co. analyst Timothy Anderson, saying: “The fact that the company is talking about the original split-up decision timeline of late 2016 almost seems to suggest they have given up on inversion.”
Meanwhile, Sean Williams, writing at the Motley Fool, said flatly: “Both companies will be just fine over the long run. Most importantly, I believe shareholders can take solace in the fact that both companies should be just fine operating as separate entities for many years to come,” though he did admit that while “the two companies will put their break-up scars in the rearview mirror pretty quickly,” investors “may be less forgiving.”
Williams also noted that tax inversions in the United States are as good as dead for the short run at the very least, writing, “we learned that the government is done beating around the bush when it comes to U.S. companies taking advantage of tax inversion opportunities. The new regulations all but ensure that tax inversions of the magnitude we've witnessed in recent years (e.g., Medtronic-Covidien) are likely dead. It's possible that smaller-case inversions may still be sought, but the tax benefits of relocating to an overseas market have been severely crimped.”
It wasn’t a surprise to many analysts that the Pfizergan merger would fall apart with the most recent rule changes, among them John Colley, a professor of practice in the Strategy and International Business Group of Warwick Business School, who wrote (after Treasury made the changes but before Pfizer pulled the plug): “The move to limit tax inversions by the U.S. government has wiped $20 billion off the share price of Allergan, which broadly equates to the tax benefit arising from Pfizer merging with Allergan ... Other than the tax benefits, it was never clear what other benefits really existed in the deal. Pfizer does need growth prospects and Allergan did offer some better prospects than Pfizer, as Pfizer is struggling for significant new drugs and has large cash piles which cannot be repatriated to the U.S. and shareholders for tax reasons.”
In a later statement, after Pfizergan was history, Colley wrote: “In effect this is a major success for the Obama administration, while for Pfizer it is bad news as tax matters have dominated its strategy for more than three years,” but added on a more encouraging-yet-chiding note that “Perhaps now Pfizer and other pharmaceutical businesses can focus on drug development rather than financial engineering. In 2015, around $600 billion of acquisition activity occurred in the pharmaceutical industry, a significant proportion was driven by U.S. tax rules and avoiding tax.”
Sangeetha Prabakaran, a research manager in Frost & Sullivan’s Transformational Health practice, largely agrees with many of the points both Williams and Colley made, writing: “Pfizer’s reliance on Allergan was more on the tax sops and less Botox or Restasis sales, since Pfizer’s own breast cancer drug Ibrance has picked up strongly. Its pipeline of hypolipidemic drugs is strong and Pfizer needs to stay focused on bringing the next Lipitor to market. Allergan off-late has been more focused on Teva to hive off its generics and reduce its debt. Allergan may continue to scout for generics partners while consolidating its position with Botox and building on a strong pipeline on age-related macular degeneration and depression.”

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