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Pfizer to walk away from Allergan deal

April 6, 2016
Life sciences

Pfizer Inc. has decided to kill its planned $150 billion takeover of Allergan PLC, after the Obama administration took aim at a deal that would have moved the biggest drug company in the U.S. to Ireland to lower its taxes, according to people familiar with the matter.

The companies are expected to announce the deal’s termination as early as Wednesday morning, after Pfizer’s board voted Tuesday to halt the combination and the New York-based pharmaceutical company then notified Dublin-based Allergan, the people said.

Pfizer will pay Allergan a small breakup fee, the people said. The merger agreement called for a fee covering Allergan’s integration-planning expenses of up to $400 million in the event that tax-rule changes rendered the deal unworkable.

Late Tuesday, the sides were still working out how much the planning had cost Allergan, but it is expected to be much less than the full $400 million, one of the people said.

The decision to walk-away is the latest setback in Pfizer’s long-running efforts to overcome what Chief Executive Ian Read has said was the company’s competitive disadvantage with foreign rivals that faced significantly lower tax bills.

In 2014, Pfizer had tried but failed to buy British drugmaker AstraZeneca PLC. Afterward, it looked for a new partner, before finally reaching terms with Allergan.

By combining with Ireland-based Allergan, Pfizer could not only cut its tax rate but also get access to the billions of dollars in revenue it was keeping overseas in order to avoid paying U.S. taxes on top of the taxes it had already paid in foreign countries.

The combination also had nontax benefits for Pfizer, including access to Allergan’s portfolio of strongly growing products like antiwrinkle treatment Botox, dry-eye treatment Restasis and new irritable-bowel drug Linzess.

A combination also might have paved the way for Pfizer to shed its collection of cash-generating but older slower-growth drugs.

Yet even without Allergan, Pfizer has started to increase sales, after overcoming generic competition to big sellers like cholesterol fighter Lipitor.

Sales of its new breast-cancer drug Ibrance have started strongly. And the company has a new kind of cholesterol drug in development, which analysts say would compete in a lucrative market.

Neither Pfizer nor Allergan had done extensive planning for a combination, with Allergan more focused on completing a deal to sell its generic drugs business to Teva Pharmaceutical Industries Ltd., according to one of the people familiar with the situation.

If the Teva deal is completed, Allergan will have eliminated its debt accumulated with deals like its $70.5 billion take-over by Actavis last year, while the escalating sales of Botox and other products keep the company among the drug industry’s fastest-growing firms. In Allergan’s pipeline are drugs for age-related macular degeneration and depression that could be big sellers.

Allergan would likely look to do more acquisitions of its own once the Teva deal closes, according to a person familiar with the matter. If its stock stays low, the company might also repurchase shares, the person said.

Tax-inversion deals have become a commonplace in U.S. corporate deal-making. They have also become a talking point in the U.S. presidential campaign, with certain candidates attacking the uprooting of American companies and departure of tax receipts.

The tie-up between Pfizer and Allergan, the biggest merger announced last year—the busiest ever for takeovers —was a particular campaign target. Republican and Democratic presidential candidates have criticized the deal.

President Barack Obama on Tuesday called corporate inversions, in which a U.S. company buys a foreign rival and adopts its lower-tax jurisdiction, one of the “most insidious tax loopholes out there.” Companies that have inverted frequently make more acquisitions of U.S. companies to bring them on to their lower-tax platforms.

The problem, Mr. Obama said, isn’t that companies are engaging in illegal activity, but what is legal in the first place.

The government had so far been unable to do much to stop corporate inversions, but that clearly changed with Monday’s publication of a third installment of proposed rule changes, the stringency of which came as a surprise to many.

In an effort to crack down on what the Treasury Department calls “serial inverters,” the new regulations would disregard three years’ worth of U.S. acquisitions when determining a foreign company’s size under the tax code.

That complicated the finely tuned math that was crucial for inversions like Pfizer’s to work. To reap maximum benefits, shareholders of the inverting company should own between 50% and 60% of the combined entity. Between 60% and 80% also works, but the tax perks are diminished, and above 80%, they are lost entirely. So U.S. companies need inversion partners that are at least one-quarter their size, and ideally more like two-thirds.

When the Allergan deal was struck last year, Pfizer’s market capitalization was about $200 billion and Allergan’s was about $120 billion. Pfizer’s shareholders would own 56% of the combined company.

But stripping out three years’ worth of deals done by Allergan—which Treasury certainly would consider a serial inverter—that math no longer works. Allergan has 395 million shares outstanding.

It has issued about 260 million shares for big deals, including the $25 billion takeover of Forest Laboratories and the $66 billion combination of Actavis and Allergan last year.

Stripping those out leaves about 130 million shares, worth only about $30 billion. Under the current merger ratio, Allergan shareholders’ stake in the combined company would likely drop into the high teens.

In other words, in the eyes of Treasury, Allergan would have been too small to be Pfizer’s inversion partner.

Allergan shares fell 15% Tuesday, a sign that many investors considered the deal to be dead. Pfizer shares rose 2.1%.

The White House denied the new rules were targeted at a specific company.

“The Treasury Department is not focused on a specific transaction, it’s focused on specific loopholes,” White House press secretary Josh Earnest said. The White House declined to address the specific Pfizer and Allergan situation, but Mr. Earnest said the administration would be “pleased” if inversion deals fell through.

Treasury’s new three-year rule is less likely to trip up other companies that have been pursuing inversions. Ireland-based Tyco International PLC, the target of Johnson Controls Inc.’s pending inversion, has made few acquisitions in the past three years. The same goes for Canada’s Progressive Waste Solutions Ltd., which is Waste Connections Inc.’s intended ticket out of the U.S. tax net.

Shares in those companies fell on Tuesday, though less dramatically than Allergan’s. Progressive Waste lost 3.3%, and Waste Connections declined by 2.5%. Meanwhile, Tyco closed 3% lower, and Johnson Controls fell by 2.2%. IHS Inc. and its planned inversion partner, Markit Ltd., both lost 2.6%.

Waste Connections and Progressive Waste said in a statement Tuesday that they are committed to their deal. They project the regulations will affect less than 3% of the combined company’s expected first-year adjusted free cash flow of $625 million.

A spokesman for Johnson Controls said the companies were reviewing the proposed regulations. IHS and Markit said in a statement that they don’t expect the new rules to trip up their deal.

Those deals aren’t entirely immune from the new regulations. Treasury also is attacking a practice known as earnings stripping, which is when inverted companies lend money to their American subsidiaries and use the interest payments, which are tax deductible against the U.S.’s 35% corporate-tax rate, to lower their U.S. taxes. Treasury will be able to stop treating those loans as debt, negating their benefits.

Mr. Obama on Tuesday said the U.S. should revamp the tax code and lower the corporate tax rate. “Only Congress can close [the door to inversions] for good and only Congress can make sure that all the other loopholes that are being taken advantage of are closed,” he said.

Big business groups such as the U.S. Chamber of Commerce and the Business Roundtable criticized the rules and Mr. Obama’s rhetoric.

“There is nothing ‘patriotic’ about politicians bullying America’s job creators for legally trying to level the playing field,” said Bruce Josten, the chamber’s top lobbyist.

Rep. Kevin Brady (R., Texas), chairman of the House Ways and Means Committee, echoed some of those sentiments, criticizing the rules as “punitive” steps that would hurt U.S. companies and discourage investment.

By Jonathan D. Rockoff, Liz Hoffman and Richard Rubin

Source: Wall Street Journal

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