Pfizer (NYSE:PFE) confirmed this morning that management has made two attempts to engage British-Sweden based biopharma AstraZeneca (NYSE:AZN) in talks about a possible merger. Per Pfizer's press release, the offer would consist of a mixture of cash and shares in the combined megacompany, worth upwards of $100 billion to current AstraZeneca shareholders. Moreover, the deal would come at a 30% premium compared to AstraZeneca's share price at the beginning of the year. Despite this premium, AstraZeneca's management declined Pfizer's offers to even discuss a potential merger, with Pfizer subsequently announcing that the company is "considering its options with respect to AstraZeneca."
While this recent announcement makes it sound like a hostile takeover could be in the works, it's important to consider why Pfizer is so interested in AstraZeneca in the first place. After all, Pfizer's stated offer of nearly $100 billion might fetch the company other large pharmas like Amgen, Eli Lilly, or even Bristol-Myers Squibb for that matter. Let's consider this issue from a couple of different angles to see if we can figure out the prime mover for what would be one of the largest mergers in pharma history if it occurred.
Pipeline-alone hypothesis doesn't hold water
Pfizer hinted in its press release that it's particularly interested in AstraZeneca's oncology pipeline, saying that it was keen to explore "opportunities for greater depth in immuno-oncology." And while Pfizer did mention some of AstraZeneca's experimental therapies for other areas of interest, such as cardiovascular and diabetes, they spent a fair amount of ink discussing possible synergies between the companies' oncology units. Put simply, Pfizer is saying that it wants to bolster its somewhat weak oncology pipeline that looks pretty weak beyond palbociclib, an experimental breast cancer drug.
On its face, Pfizer's interest in boosting its cancer pipeline as a prime mover for a deal makes some sense, given that it has fallen behind its peers in the development of cancer immunotherapies in general. Yet, there are some glaring problems with this explanation. First off, AstraZeneca's immunotherapy pipeline is still in its early days, with most of these products being years away from a potential regulatory filing. In other words, it's hard to imagine that a seasoned pharma like Pfizer would be willing to value early stage candidates at more than a few hundred million each due to their inherent risk. Indeed, we've seen a number of promising cancer immunotherapies flame out in mid to late-stage trials over the years, highlighted recently by GlaxoSmithKline's MAGE-A3 vaccine that failed in a late-stage study last March.
Secondly, Pfizer could buy a handful of smaller biotechs with promising oncology candidates that would cost them significantly less than the deal proposed with AstraZeneca. At the end of the day, this explanation doesn't create enough value to be a major contributor in Pfizer's thought process, or at least it shouldn't, in my opinion.
How about cost savings?
Digging through the press release a bit more, we come to the concept of "synergies" that would be created by such a deal. While that sounds somewhat vague, I think we can nail this term down in more concrete terms, namely taxes. Let's discuss why.
Pfizer has a tax problem with its foreign earned income. In 2013, the company reported that its effective tax rate increased to 27.7% from 25.7% a year earlier largely because of taxes on money that was being repatriated for dividend payouts and stock buybacks. Moreover, the company has been hesitant in repatriating money for years because of this tax issue.
Getting to the point, a merger with AstraZeneca could save Pfizer significantly on its effective tax rate for income earned abroad. What's particularly telling is Pfizer's comments on this issue, stating that, "a new U.K.-incorporated holding company would not subject AstraZeneca's non-U.S. profits to U.S. tax, which would be in the best interests of the combined company's shareholders". What's implied in that statement is that Pfizer's non-U.S. profits would also no longer be subject to the higher U.S. tax rate.
The next few days may see Pfizer turn up the heat on AstraZeneca to come to the bargaining table, as they've made it abundantly clear, they are interested in pushing through a deal. My view is that Pfizer's interest in AstraZeneca has more to do with lowering its effective tax rate, which would create value for Pfizer shareholders in the long run. I don't see how the pipeline could be driving this transaction on its own -- after all, Amgen, Bristol-Myers, and Eli Lilly, in my opinion, all have more compelling pipelines than AstraZeneca, and they all could run around $100 billion or so in a buyout. What's key to understand is that AstraZeneca has an address that is favorable tax-wise and has the infrastructure in place (including a pipeline that may generate some winners long-term) to make a deal work between two big pharma companies.