On May 16, Pfizer (PFE 3.64%) announced that it was going to take out $31 billion in fresh debt to pay for its purchase of Seagen (SGEN), an oncology drug developer. In total, it'll pay $43 billion for the company in a transaction that's set to reshape its future, and power shareholder returns for the remainder of the 2020s and perhaps beyond.
Somewhat counterintuitively, investors should interpret this debt issuance as good news for Pfizer's stock. Here's why.
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The benefits to Pfizer could be huge
The point of buying Seagen is that the company's 31 drugs in development could yield as much as $10 billion in annual revenue for Pfizer by 2030. They'll nearly double the size of Pfizer's oncology portfolio, which could position the company to be a global leader in cancer therapeutics for years to come. And when the transaction closes in late 2023 or early 2024, Seagen will also contribute its top line of approximately $2 billion to Pfizer's, though it isn't making a profit.
Grabbing Seagen is one of the pillars of management's plan to add $45 billion in fresh annual revenue before the end of the decade, to reach a total of around $84 billion annually. It will help offset the anticipated loss of around $17 billion in sales from expiring exclusivity licenses for its medicines, and stem some of the losses from its rapidly eroding coronavirus drugs.
Taking out more debt does involve paying some interest expenses, and it won't push the company to top 2022's more than $100 billion in sales anytime soon. But it's also a sign that management is willing to make big and bold bets for the sake of stoking growth.
Don't worry about this company running up the tab
While the potential advantages of the purchase are likely to be significant, Pfizer shareholders are correct to question the wisdom of taking out gargantuan tranches of new debt. After all, there's always a risk that Seagen's much-vaunted pipeline fails to yield enough new medicines to justify the costs of the investment and interest fees. But a closer inspection of Pfizer's balance sheet and cash flow statement can put these concerns to rest.
Right now, Pfizer has about $20 billion in cash and equivalents, so it won't be using all of its liquid assets for the acquisition. As of the first quarter of 2023, it has $34.9 billion in long-term debt, so it'll have a total of roughly $65.9 billion after issuing the new debt.
That might sound like a scary amount until you consider that in 2022 free cash flow (FCF) was just over $26 billion. In 2019, even before Pfizer's massive windfall from sales of coronavirus products, it had FCF of nearly $10 billion. So as vaccine sales continue to erode due to falling demand, the company will still have plenty of money to service its debt.
Shareholders won't need to wait that long to see if the purchase is yielding fruit. Company leaders expect that between three and four years after the deal closes, the acquisition will start contributing to adjusted earnings per share (EPS). After paying down some of the debt it plans to rack up, Pfizer will focus on both reinvesting earnings into further growth and returning capital to shareholders in the form of dividend payments and share repurchases. And management probably wouldn't bother to talk about a shift toward returning more capital if its plan was to slowly pay down the debt over the course of many years.
Should you buy the stock?
The debt isn't a sign that Pfizer's stock is a smart investment for you specifically, even if it's good news for the company's future. The same goes for the Seagen purchase. In the near term, it's highly likely that declining need for Pfizer's coronavirus products will continue to be a headwind. You probably shouldn't expect this stock to grow as quickly as a smaller biopharma business.
Still, if you're in the market for a safe-but-still-slated-to-grow company that pays a decent dividend -- currently yielding 4.5% -- it could be a good option. Just remember that you'll probably need to wait a few years before there's enough spare cash flow for Pfizer to start hiking its dividend faster, or buying shares back in larger volumes.
