What: Shares of the Irish biopharma Allergan (NYSE:AGN) fell by as much as 22.5% in after hours trading on exceptionally high volume yesterday after the U.S. Treasury Dept. and Internal Revenue Service issued new rules aimed at curbing so-called tax inversions. Allergan is set to merge with Pfizer (NYSE:PFE) in the second half of 2016, and these new rules may delay, or perhaps even block, this ginormous deal.
In response, Allergan and Pfizer released a joint press release last night, stating that neither company will comment on the Treasury's Dept.'s actions until they have completed a review of the new rules.
So what: If this after hours move holds, Allergan's shares will start the day off well below their former 52-week lows, according to data provided by S&P Global Market Intelligence. Put simply, Allergan is slated to take a roughly $24 billion haircut at the start of trading today.
Now what: The head scratching part about Allergan's after hours nosedive is that the market was assigning a higher premium to Allergan as a stand alone company prior to this deal becoming public knowledge. So, if anything, Allergan's shares should be moving up on the possibility that this merger won't go through -- not down.
What's going on? I think there are two possible issues at play here. The first is the spectacular implosion of fellow drugmaker Valeant Pharmaceuticals (NYSE:BHC) over the last few weeks that has apparently spooked healthcare investors. The issue is that Valeant has relied on an aggressive growth-by-acquisition strategy to build out its business in a manner similar to Allergan -- causing both companies to take on substantial amounts of debt in the process. As a result, Allergan and Valeant have become tightly linked in the minds of some investors.
Having said that, Allergan and Valeant have taken vastly different approaches to drug price increases following a buyout, implying that there are few shared characteristics beyond a penchant for aggressive deal-making and a bloated balance sheet between the two companies.
The other possibility is that the market is already baking in the loss of revenues from Allergan's $40.5 billion sale of its generic drug unit to Teva Pharmaceutical Industries (NYSE:TEVA) later this year. After all, this business segment sports over 1000 products and has been a major growth driver for the company in the past. So, while this forthcoming deal with Teva would obviously help to dramatically lower Allergan's hefty debt load, the market might be frowning on the loss of these revenues moving forward.
Is Allergan worth buying on this pullback? As an Allergan shareholder, I'm obviously biased, but I think the answer is a resounding "yes". According to the merger agreement filed with the SEC, Pfizer would most likely now owe Allergan a whopping $3.5 billion as a break up fee in the event this merger doesn't go through as planned.
Besides this unsightly break up fee, I think it's important for shareholders to understand that this deal was never completely about Pfizer's effective tax rate. At the end of the day, Pfizer desperately needs an injection of new growth products and a way to eventually shed its struggling legacy products business. This merger with Allergan can solve both of those problems for Pfizer, implying that there compelling reasons to go forward with this deal other than a lower effective tax rate. As such, I'm cautiously optimistic that this merger will indeed come to fruition.
Last but not least, I think the concerns that Allergan is another Valeant are simply overblown. After all, Allergan's former managerial team -- prior to its merger with Actavis -- fought off a hostile buyout attempt by Valeant, largely because of the issues that are now coming to light about the drugmaker's finances.
So, it stands to reason that Allergan's management wouldn't have been so concerned about the long-term trajectory of the company if there was a major bombshell hiding in its own balance sheet -- not too mention the fact that Actavis probably would have scuttled the deal if a major red flag like accounting discrepancies popped up.
All told, I think Allergan was already undervalued based on its strong product portfolio and top-notch managerial team, making a 20% plus pullback a tremendous buying opportunity for investors that are willing to deal with some short-term volatility.