U.S. stocks are little changed on the eve of the Thanksgiving holiday, with the Dow Jones Industrial Average (DJINDICES:^DJI) and the S&P 500 (SNPINDEX:^GSPC) up 0.18% and 0.15%, respectively, at 12:45 p.m. EST. Shares of Pfizer and Allergan PLC are showing solid gains for the second straight day, more than making up for Monday's losses in the wake of their merger announcement.
On Monday, this column highlighted three reasons Pfizer shareholders ought to be skeptical of its proposed $160 billion merger with Allergan PLC. My concerns were related to Pfizer's ability to earn an economic return on the deal. However, it turns out the two parties have concerns of their own regarding the viability of the deal, as evidenced in the published merger agreement.
Merger agreements typically specify termination fees that one party must pay the other if the transaction falls through for specific reasons.
The Pfizer-Allergan agreement sets the termination fee for both acquirer and target at $3.5 billion under most of the possible situations they describe. Given the size of the deal, that figure isn't raising any eyebrows.
When Pfizer vied to acquire to Wyeth in 2009 at an announced total value of $64.2 billion, for example, the acquirer termination fee was $4.5 billion, with the target's fee set at $2.0 billion, according to data from Bloomberg.
However, the merger agreement also carves out two special cases with lower termination fees:
- If either company terminates the deal "due to an adverse change in law," they are liable to pay the other party a termination fee of just $400 million.
- If either company's shareholders vote down the deal unilaterally, and neither board of directors change their recommendation, the company with the refusing shareholders must pay a termination fee of $1.5 billion.
Furthermore, The New York Times has reported that the votes are to be held one day before the transaction date, giving shareholders the maximum possible time period to reconsider their decision.
Both conditions suggest the companies do not have full confidence that the deal will be completed, either due to a regulatory challenge or because they may fail to convince both sets of shareholders of the merits of the transaction.
The political risk is clear. The deal's economic viability turns on the successful completion of an "inversion," whereby Pfizer redomiciles outside the U.S. in order to lower its tax burden. The Obama administration has been trying, mostly unsuccessfully, to discourage such transactions.
On Monday, Hillary Clinton's campaign released a statement on the deal:
This proposed merger, and so-called inversions by other companies, will leave U.S. taxpayers holding the bag. As president, I will fight to reform our tax system to reward growth, innovation, and job creation here in the United States. We cannot delay in cracking down on inversions that erode our tax base.
The deal also drew condemnation from her Democratic rivals for the nomination, Senator Bernie Sanders, who called on the current administration to block the transaction, and former Maryland governor Martin O'Malley.
Republican candidate Donald Trump didn't mince words, either, saying, "the fact that Pfizer is leaving our country with a tremendous loss of jobs is disgusting."
Pfizer has been stung recently on another huge inversion acquisition it was trying to put together: In May of last year, it was forced to abandon its pursuit of British pharmaceuticals group AstraZeneca PLC due to political pressure in the United Kingdom.
Apparently, the market believes the risks to the deal that are reflected in the merger agreement are significant. According to data from Bloomberg, the probability of the deal's success that is implied in both companies' share price is just 15%! With the deal expected to close in the second half of 2016, by next Thanksgiving, we ought to know whether or not Pfizer CEO Ian Read has a big something to be thankful for.
Alex Dumortier, CFA, has no position in any stocks mentioned. The Motley Fool recommends AstraZeneca. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.