US Inversion Plan Could Scupper Pfizer-Allergan
What a difference a day makes. On Apr. 3, European time, Pfizer and Allergan said the US Federal Trade Commission’s deeper probe into their potential merger, the so-called second request, would not derail their plans to complete the deal in the second half of this year.
A day later, the news agency Reuters, citing an unnamed source, reported that Pfizer appeared to be leaning toward abandoning its $160 billion agreement with Allergan in light of proposals by the US Treasury to curb tax inversion transactions such as this, in which Pfizer would officially move its headquarters to Allergan’s current base in Ireland while remaining physically in the United States.
On news of the proposals, Allergan’s share price plunged by 22%. The company’s market capitalization, which stood at nearly $110 billion before the announcement, slipped below $90 billion.
As discussions between the two companies and their lawyers were planned to continue until the late hours of Apr. 5 European time, how the scenario would look on Apr. 6 was anybody’s guess. In any case, the Reuters source said Pfizer is unlikely to be willing to change the terms of its deal or engage in a fight with the Treasury.
Many observers speculated that the steps taken by the US Treasury Department were aimed directly at blocking major taxpayer Pfizer’s exit from the country’s jurisdiction while remaining on its soil.
Secretary of the Treasury, Jack Lew said the Department was focusing on transactions that generate large interest deductions on tax bills by simply transferring debt between subsidiaries without financing new investment in the United States.
The potential killer blow to Pfizer-Allergan, according to the newspaper Financial Times, could be a provision of the proposal to alter the way the size of companies in mergers is calculated.
To qualify as an inversion and gain the attendant tax benefits, a merger then would have to result in the shareholders of the non-US company owning a minimum percentage of the new entity, usually 20%.
Applied to the treatment of past combinations, this could make Allergan appear smaller and make it harder for it to reach the ownership threshold. Under this aspect, the business news channel CNBC explained, Allergan's most recent deals, including the $66 billion merger with Actavis, the $25 billion purchase of Forest Laboratories and the $5 billion takeover of Warner Chilcott, would not be counted.
In a joint statement, Pfizer and Allergan said they were conducting a review of the Treasury’s actions. Prior to completing the review, they added, “we won’t speculate on any potential impact.”
Pfizer and Allergan are said to already have an exit strategy in place, in the form of an agreement that either party may terminate the deal if an adverse change in US law would cause the combined company to be treated as a US domestic corporation for federal income tax purposes.
The terminating party would have to pay the other company up to $400 million for its expenses.
Considering how the stocks were trading on Apr. 5, “the market thinks the deal is almost dead," Les Funtleyder, healthcare portfolio manager at E Squared Asset Management in New York, whose firm holds Pfizer shares, commented.
One of the most important questions is, “if the deal breaks, where should Allergan trade?” Wells Fargo analyst David Maris wrote in a research note on Apr 5.
Others wondered whether Treasury’s latest proposals – its third attempt during the Obama administration to block inversions – would actually succeed. The first two trial balloons fizzled.
