Image source: Pfizer.
In terms of deals for the ages, the merger of Pfizer (PFE 0.21%) and Allergan (AGN +0.00%) was it -- and by "it" I mean the expected largest deal in healthcare history. The combined entity was designed to become the largest drug developer in the world, capable of more than $25 billion in operating cash flow by 2018 and expected to possess more than 100 mid to late-stage pipeline products.
In addition, the deal was structured in such a way that Allergan was "acquiring" the larger Pfizer, with Allergan shareholders expected to receive 11.3 shares of Pfizer's common stock for each share of Allergan. Structuring the deal this way would have allowed Pfizer to avoid the U.S. Treasury Department's tax inversion rules and redomicile its headquarters to Ireland, where Allergan is based. Ireland's corporate income tax is less than half that of the United States, and the tax savings alone would have been well in excess of $1 billion annually.
How the Treasury killed PfizerGan
However, the Treasury put the kibosh on this merger on April 4, when it released some 300 pages of new tax-inversion regulations. While not specifically citing the Pfizer-Allergan merger, two of the new regulations in particular took direct aim at it.
First, the new tax-inversion laws target serial inverters -- overseas companies that have rapidly grown in size by acquiring U.S. assets -- by not counting the value of assets acquired on a trailing three-year basis when taking a deal into consideration. In easier-to-understand terms, Allergan's purchases of Warner-Chilcott for $5 billion and Forest Laboratories for $25 billion, and its merger with Actavis, were all going to be thrown off the books when calculating the Pfizer-Allergan deal value since they occurred within the past three years. This brought Allergan's deal value down to $106 billion from $160 billion and put it well below the threshold that Allergan shareholders would have been required to own of the new company if Pfizer were to relocate its headquarters.
Secondarily, the Treasury severely limited the practice of earnings stripping, in which overseas entities lend money to their U.S. subsidiaries and use the tax-deductible interest to lower their U.S. corporate income tax rate.
Image source: AstraZeneca.
Three drug developers Pfizer might pursue
With the deal now officially dead and each company going its own way, Pfizer is likely to remain on the hunt for acquisitions. Although, as we've heard from Pfizer's board previously, it's only interested in deals that'll move the needle, which is a fancy way of saying that anything sub-$5 billion (choosing an arbitrary figure here) is probably not on Pfizer's radar.
So which drug developers might Pfizer go after? I'd suggest these three are distinct possibilities.
1. AstraZeneca
No irony is lost on the fact that the emphasis on tax inversions began almost exactly two years ago, when Pfizer did its best to lure U.K.-based AstraZeneca (AZN +0.00%) into a buyout. At the time, buying AstraZeneca would have allowed Pfizer to escape what I figured to be around $1 billion in corporate income taxes per year if it were able to relocate its headquarters to the U.K.
However, even without juicy tax benefits, a deal with AstraZeneca could make a lot of sense for both companies. The reason is that each company has what the other needs.
Both Pfizer and AstraZeneca are struggling to grow demonstrably under the weight of patent expirations. But the therapeutic area that each has been struggling most is where the other can step in and assist.
Pfizer, for instance, lost patent exclusivity on cholesterol-fighter Lipitor and has struggled to grow its cardiovascular and metabolic franchises. By contrast, AstraZeneca has been shoring up its CV and metabolic franchises. It acquired a 100% stake in its diabetes alliance with Bristol-Myers Squibb (BMY 0.60%) in 2014, including Farxiga, a highly coveted SGLT2-inhibitor, and it gobbled up ZS Pharma just a few months prior to get its hands on the company's hyperkalemia treatments. Cardiovascular and metabolic drug products are AstraZeneca's main growth drivers.
Image source: Pfizer.
In turn, AstraZeneca hasn't exactly wowed Wall Street with its oncology franchise. Arimidex, Casodex, and Iressa all turned in a single-digit constant currency sales decline for AstraZeneca for the full year 2015. This is where Pfizer's oncology pipeline could be helpful. Breast cancer drug Ibrance is growing like wildfire, and Pfizer's experimental cancer immunotherapy avelumab (which it's developing with Merck KGaA (NASDAQOTH: MKGAY)) looks to make it to pharmacy shelves well ahead of AstraZeneca's experimental immunotherapy products.
A pairing of struggling equals may still make sense here, even if the tax benefits will be a moot point.
2. Bristol-Myers Squibb
Another idea, which was also hatched roughly two years ago, is that Pfizer might be interested in pursuing a deal to acquire U.S.-based Bristol-Myers Squibb.
Why Bristol-Myers Squibb? Two primary reasons.
First and foremost, cancer immunotherapies. I repeat, cancer immunotherapies. Pfizer is bent on making an impact on the cancer immunotherapy market, but it was admittedly a bit late to the game. This is why Pfizer entered into an arguably expensive deal with Merck KGaA in November 2014 for avelumab that saw it pay Merck KGaA $850 million upfront, dangle up to $2 billion in development, regulatory, and sales-based milestone, and even offer up co-promotion agreements for Xalkori in the U.S. and other key markets.
Image source: Bristol-Myers Squibb.
Buying Bristol-Myers Squibb would give Pfizer access to the No. 1 immunotherapy on the market, Opdivo, which is approved to treat second-line non-small-cell lung cancer, metastatic melanoma, and second-line renal cell carcinoma, but could have a long list of approvals and combinations to come. Added in with avelumab, Pfizer could become an immunotherapy giant.
The second reason Bristol-Myers makes sense is potential cost synergies. Overlapping oncology research would likely result in cost-cutting, and both companies already co-market blood thinner Eliquis, which is expected to grow into a multibillion-dollar giant. Also attractive is that Bristol-Myers' full-year 2015 effective tax rate was just 21.2% compared to Pfizer's 24%. Even a modest move lower in effective tax rate can mean hundreds of millions in extra profit.
3. BioMarin Pharmaceutical
Lastly, I could see Pfizer turning its attention to an acquisition similar in size to Hospira (this was about a $17 billion deal) and making a run at rare disease specialist BioMarin Pharmaceutical (BMRN 0.88%).
Make no mistake about it: Pfizer enjoys being in the limelight for major and/or chronic diseases. But one often overlooked primary areas of focus for Pfizer is rare-disease drugs.
Image source: BioMarin Pharmaceutical.
Rare disease drugs, commonly known as orphan therapies, treat 200,000 or fewer patients in the United States. Generally speaking, the smaller the prospective patient pool, the larger the price tag of an approved therapy. Best of all, orphan therapies come with extra competitive protections and rarely contend with a lot of competition, if any. Orphan drugs may also escape generic competitors once they come off patent, too. Thus, rare-disease drugs can be incredibly profitable.
The problem, as BioMarin has discovered after bringing five Food and Drug Administration-approved products to market, is that it can take time to bring costs under control while also continuing to research new rare-disease indications, market existing rare disease therapies, and generate more revenue in each successive year. At its current pace, BioMarin isn't expected to be healthfully profitable until fiscal 2019.
If Pfizer were to acquire BioMarin, chances are that it would be able to use its size to get BioMarin's cost structure way down, meaning profitability off BioMarin's existing products would be either immediate or occur within a year, in my best guess. Plus, BioMarin's losses could allow Pfizer to take advantage of a myriad of tax loss carry-forwards, including $300 million in federal research and development and orphan drug credit carry-forwards. This could provide a quick boost to Pfizer's EPS that'll help offset any acquisition-based costs of the deal.
What drug developer do you think Pfizer could go after next? Share your ideas in the comment section.
