Image source: Pfizer.
Monday started off with a bang this week, with a long-awaited rumor becoming a reality. As issued in an early morning press release, Pfizer (PFE 1.21%) and Allergan (AGN +0.00%) announced they will merge into a single entity, forming the largest pharmaceutical company on the planet.
The Pfizer-Allergan deal, by the numbers
Under the terms of the deal, Allergan shareholders will receive 11.3 Pfizer shares for each share they own. Based on Friday's close, this values Allergan at $363.63 per share, or a premium of 16.4%. The combined entity, which will keep the Pfizer name and bear the familiar "PFE" ticker symbol, is expected to generate in excess of $25 billion in cash flow beginning in 2018, will sport more than 100 mid-to-late-stage clinical development programs, could deliver in excess of $2 billion in cost synergies, and should be accretive to Pfizer's bottom line by as early as 2018, with a high-teen-percentage EPS accretion witnessed by 2020.
In addition, Allergan is expected to add depth to Pfizer's established product portfolio, perhaps providing a footing in the future for a possible split into two separate entities. If you recall, the loss of exclusivity on key blockbuster therapies, such as Lipitor and Celebrex, have weighed on Pfizer's top and bottom line, and the company has struggled to find ways to maximize the value of its mature drug portfolio.
Also, the deal is structured in such a way that Allergan, the smaller company, is purchasing Pfizer, the larger company. The reason the deal is structured this way is that it allows Pfizer to redomicile its headquarters to Ireland, which is where Allergan is based, following the merger. Ireland's highest marginal corporate tax rate is just a fraction of what corporations pay in the United States, thus allowing Pfizer to keep more of its profits instead of handing them over to Uncle Sam. Pfizer anticipates its effective tax rate will fall from 25% to somewhere between 17% and 18% following the first year of completion. This tax benefit, commonly known as a tax inversion, is expected to provide the bulk of the cost savings from the tie-up.
Image source: Flickr user Nguyen Hung Vu.
What Pfizer really bought when it acquired Allergan
On the surface, it's clear that the Allergan deal brings Pfizer a foot in the door in a number of new fields.
Allergan's primary focus has been, and will continue to be, dermatology and aesthetics. Its top-selling drug is Botox, an injection used to treat a variety of ailments, but best known as a temporary fix to remove facial wrinkles. Botox is on pace to generate well over $2 billion in sales this year.
On top of dermatology and aesthetics, Allergan also specializes in drugs designed to treat central nervous system disorders, eye care, women's health, and cardiovascular disease.
Let's not also forget that Allergan recently completed its merger with Actavis, which itself had quite an extensive portfolio of drugs and an active generic drug portfolio. Generic drugs may boast lower margins, but they've become a key tool, alongside the possible use of biosimilars, to combat the expected loss of blockbuster drugs to patent expirations.
However, what's really odd about this merger is that few of Pfizer's and Allergan's therapeutics areas of focus align. With the exception of cardiovascular and neuroscience to some level, Pfizer's focus on oncology, inflammation, vaccines, and immunology is an industry apart from Allergan's therapeutic focuses.
Image source: Pixabay.
On one hand, that's probably a good thing, as it could give both companies a pass in the eyes of regulatory agencies that could prevent this merger from happening. With both companies being remarkably different, their combination shouldn't dramatically alter the competitive drug landscape or adversely affect pricing. Of course, it still remains to be seen if U.S. regulators will greenlight the deal, considering its enormous size and tax implications.
But, this merger is about more than just Botox and Viagra joining forces. What this deal really buys Pfizer is time.
Why time is so important to Pfizer
Wall Street and investors have hounded Pfizer to do something to reinvigorate growth. With a midpoint expectation of $48 billion in total sales for 2015, Pfizer's full-year revenue will now be down in five consecutive years, having fallen from a peak of $67.8 billion in 2010. The loss of patent exclusivity on key drugs is almost entirely to blame for this drop-off.
Pfizer has tinkered with numerous options to grow its business, but none have exactly panned out. The idea of spinning off its global established products portfolio (its mature products, some of which have lost their exclusivity) has been thrown around on numerous occasions, but Pfizer doesn't yet have an answer as to whether this segment could stand on its own as a separate business.
Pfizer's purchase of Wyeth in 2009, which was designed to be a transformative deal that would reignite growth for the next decade, turned out to be more of a whimper than a bang for shareholders. With the exception of growing Enbrel sales outside the U.S., arguably the only benefit from the Wyeth deal was cost synergies that helped buoy share buybacks between 2011 and 2015.
Image source: Pfizer.
What Pfizer really needs to grow its business isn't another acquisition -- it's time. It needs time for newly approved breast cancer drug Ibrance to broaden its label and grow into a $3 billion-to-$4 billion drug. It needs time for avelumab to make it to market and become the next in a long list of potential cancer immunotherapy blockbusters. It needs time for its marketing efforts for Eliquis and label expansion to turn its blood-thinning franchise into a giant. Most importantly, it needs time for shareholders to forget about the patent losses and the years of stagnant growth.
The acquisition of Allergan, along with the expected profit boost caused by lower costs and a more favorable tax picture, should buy Pfizer some much needed time. It's quite possible that we'll see synergistic hiccups in the quarters leading up to and following the closing of the deal, but in my view this is really what the Allergan purchase is all about.
Does this transformative buyout make Pfizer a buy all of a sudden? To that end, I'm not entirely sure. Shareholders still need to wait another two or three years before we really see the meat and potatoes of this combination. Shareholders are also going to want to see regulators give the deal a nod before they begin speculating about future growth prospects. In my opinion, I wouldn't alter your investment thesis in Pfizer despite the announcement of this big deal -- at least for the time being.
