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Allergan's Future Gets Murky

By Todd Campbell - Apr 5, 2016 at 7:53PM

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A change at the Treasury could cause its merger with Pfizer to fall apart.


The U.S. Treasury Department is moving the goalposts on Pfizer Inc.'s (PFE 0.56%) planned $160 billion tie-up with Allergan plc (AGN). The Treasury has issued proposed rules that could put Pfizer in violation of ownership restrictions that could in turn prohibit its relocating its headquarters overseas, a move that would otherwise allow it to pocket billions of dollars over time thanks to Ireland's lower tax rate.

If Pfizer's management decides to bid adieu to the deal, rather than fight the Treasury, then it could put Allergan in a more challenging position. 

What's going on
Last fall, Pfizer agreed to a stock-swap deal with Allergan that would switch Pfizer's country of domicile from the U.S. to Ireland, lowering its tax rate from the mid-20% range to the mid-teens. Last year, Pfizer set aside nearly $2 billion to pay taxes, giving it an effective tax rate of 22.2%.

In addition to tax advantages, the combination would also net Pfizer Allergan's megablockbuster Botox and a number of intriguing pipeline medicines. However, the tax advantages associated with this deal were undeniably the major selling point of the merger.

Unfortunately, these tax deals, which are known as tax inversions, are increasingly drawing the ire of the Treasury Department, which is bristling at the thought of losing out on tax revenue.

Yesterday, Treasury Secretary Jacob Lew made that abundantly clear when he updated rules regarding tax inversions that could ultimately derail Pfizer's interest in acquiring Allergan.

Specifically, Pfizer will need to show that it will own less than 80% of the combined company, but it can't base that calculation on numbers that include acquisitions done by Allergan over the past three years.

That rule puts Pfizer in a tough spot because Allergan has been among the most acquisitive companies in the biopharma industry. Among Allergan's past deals that could now cause its agreement with Pfizer to unravel are Actavis' $70.5 billion purchase of Allergan, which led to the name change, and its $28 billion purchase of Forest Labs, a maker of depression and Alzheimer's medicine.


Gauging the impact
If the Pfizer-plus-Allergan deal falls apart, it will force investors to rethink the two companies. However, it's Allergan investors who could struggle more to value their investment.

Pfizer is one of the globe's biggest pharmaceutical companies, and while buying Allergan would have helped the company expand its footprint, the dismantling of the deal is far from a reason to sell its shares.

Pfizer has been orchestrating a turnaround since losing patent protection on Lipitor in 2011, and that turnaround includes cost-cuts, new drug launches, and a leap into the fast-growing market for biosimilars, or generic versions of top-selling biologics.

Because of its efforts, Pfizer's SG&A costs have dropped from $19 billion to less than $15 billion and rapid growth for the anticoagulant Eliquis and cancer drug Ibrance are expected to deliver total top- and bottom-line revenue growth in 2016. Overall, a post-Allergan world would still leave Pfizer deep-pocketed with plenty of financial flexibility. It could also clear the way for Pfizer to re-evaluate its business in a way that could lead to a shareholder-friendly spin-offs.

Allergan's future in a post Pfizer break-up isn't as clear cut.

Allergan markets the top-selling Botox, and it has a nice slate of promising specialty drugs in development, but its financial situation isn't nearly as healthy as Pfizer's. Allergan's penchant for deal-making has saddled it with $42.7 billion in debt and left it with just $1.1 billion in cash, and that doesn't provide it with a lot of wiggle room to invest in R&D or acquire more competitors.

Getting on firmer footing
If Pfizer does walk away, Allergan will -- hopefully -- offer up a plan to reduce its debt and put itself on firmer footing. Fortunately, it agreed to sell its generic drug business to Teva Pharmaceuticals last year, and that deal could provide it with $33.75 billion in cash and another $6.75 billion in Teva Pharmaceuticals stock. If Allergan uses all the cash it receives in that deal to pay down its debt, it could reduce what it owes to less than $9 billion. That would be a very good start in the right direction. The company could then also sell its Teva Pharmaceuticals shares, depending on restrictions that may be associated with them, to pay down more of its debt. And since a Pfizer exit would be due to a change in tax rules, then Pfizer would be on the hook for a $400 million breakup fee to be paid to Allergan, giving it some more cash to firm up its situation.

A debt reduction strategy could help keep investors focused on its research pipeline, but the FTC has yet to sign off on the Allergan and Teva Pharmaceuticals deal. If something derails that deal and puts that cash windfall in jeopardy, then Allergan gets a bit hamstrung. Therefore, until the FTC clears the deal and Allergan pockets the cash, investors might want to look for other stocks to buy.

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