This was a transformative week for the healthcare industry in a way that very few people saw coming.
The X-factor destroys the PfizerGan dream
Pfizer (NYSE:PFE) and Allergan (NYSE:AGN), two of the world's largest drugmakers, agreed to merge back in November. The deal was structured in such a way as to allow Allergan, the smaller of the two companies, to purchase Pfizer.
Allergan shareholders were set to receive 11.3 shares of Pfizer for each share of Allergan. In turn, Pfizer was primed to escape the constrictive U.S. corporate income tax rate of 35% in favor of Ireland's corporate income tax rate -- which is less than half of the rate in the United States -- by re-domiciling its headquarters to Ireland.
The deal had multiple selling points. Relocating its headquarters, plus eliminating a small handful of overlapping businesses, was expected to result in $2 billion in cost synergies. The deal was also expected to create a company with more than 100 mid-to-late-stage clinical therapies, and push annual operating cash flow above $25 billion by as early as 2018.
The deal was for naught, however, as the Treasury Department stamped out any chance of it succeeding under its current structure by introducing new guidelines covering so-called tax inversions -- where U.S. companies re-domicile overseas to avoid the U.S. corporate income tax rate -- on Monday, April 4.
The new inversion rules killed this deal in two specific ways. First, it clamped down on the practice of earnings stripping, whereby overseas subsidiaries lend to their U.S. subsidiaries, and then use the interest as a tax deduction to lower their U.S. corporate income tax rate.
Secondly, the new guidelines didn't count acquisitions from so-called serial inverters -- companies that have grown in size through tax inversions -- on a trailing three-year basis when accounting for deal value. In easier-to-understand terms, Allergan had acquired Forest Laboratories for $25 billion, Warner-Chilcott for $5 billion, and merged with Actavis, all within the past three years.
In terms of the Pfizer-Allergan combination, however, the value of these deals wouldn't be counted by the Treasury. Thus, Allergan's deal value was only on track to be $106 billion, not the purported $160 billion when it was announced. This meant Allergan's shareholders wouldn't have held the prerequisite 40% of the new entity needed for Pfizer to relocate overseas.
Three ways Pfizer can improve shareholder value going forward
With both companies now going their separate ways after officially terminating their merger, all eyes have turned to Pfizer with wonder as to how it will grow shareholder value moving forward. The way I see it, Pfizer has three choices on the table -- and it may wind up choosing them all.
1. Buy, buy, buy!
The easiest and most logical solution for Pfizer is to move on from its attempted purchase of Allergan, and use the recent weakness in biotech and pharmaceutical stock prices to go after another company. Pfizer has made it no secret that inorganic growth, which supplements and strengthens its areas of focus, is part of its growth strategy.
It's also been upfront with the idea that it wants to make deals that move the needle. In other words, don't look for Pfizer to pick up small drug developers here and there.
Which companies may Pfizer be interested in? We actually took a more in-depth look at this just days ago, but three companies that sit squarely in the spotlight are U.K.-based AstraZeneca (NYSE:AZN), Bristol-Myers Squibb (NYSE:BMY), and rare-disease drugmaker BioMarin Pharmaceutical (NASDAQ:BMRN).
Although an inversion is likely out, the selling point of an AstraZeneca buyout is the symbiotic nature of each drugmaker helping in areas where the other has weakened. AstraZeneca's promising diabetes franchise could reinvigorate growth in Pfizer's cardiovascular and metabolic segment, while Pfizer's growing cancer product portfolio and pipeline could bolster AstraZeneca's arguably stagnant oncology product portfolio and pipeline.
Buying Bristol-Myers Squibb would make sense from the perspective of becoming the leader in cancer immunotherapies. Bristol-Myers' Opdivo is the leading immunotherapy in terms of sales, and immunotherapies could hold major promise as combination therapies for all types of solid and blood-based cancers. Bristol-Myers also pays a slightly lower effective tax rate than Pfizer, potentially adding some combination incentive.
BioMarin would play to Pfizer's often overlooked focus on rare-disease drugs. Drugs that treat orphan diseases often face little-to-no competition, and are protected against competing therapies. Pfizer's size would likely help turn BioMarin's existing products profitable on a much-quicker basis. Plus, Pfizer could use various tax loss carryforwards from BioMarin to offset any adverse effects the deal might have on EPS.
2. Spin off its GEP
Secondly, Pfizer may be able to boost shareholder value by going forward with a proposed spinoff of its Global Established Products franchise, or GEP. Therapies within Pfizer's GEP have either come off patent and are exposed to generic competition, or are mature therapies with slowing growth and a dwindling time frame before generic competition enters the market.
On one hand, Pfizer's GEP is a nightmare, because sales are seemingly in a constant decline. The loss of exclusivity on drugs like cholesterol-fighter Lipitor, anti-inflammatory Celebrex, and bacterial infection drug Zyvox acts like a cement weight wrapped around the metaphorical ankles of Pfizer that holds back any attempt for its top line to advance. Jettisoning its GEP would presumably allow its faster-growing innovative drug, oncology, and vaccine segments to shine.
But Pfizer's GEP continues to provide the company with substantial cash flow. Let's remember that, even with substantially reduced sales, we're still talking about well-known brands that consumers and physicians trust. This means no need for marketing in many instances, which allows profits to flow straight to its balance sheet.
Pfizer has said that it doesn't plan to evaluate a possible spinoff of its GEP until 2018, but the Allergan deal falling through could accelerate that time frame. Pfizer's management has also stated that it would need to see four things before considering a spinoff:
- Both businesses functioning well within the Company
- A belief that both businesses could function well on their own
- A belief that there is trapped value
- A tax-efficient way to unlock that trapped value
I suspect that we're seeing the first three play out. But with the Allergan deal falling through, spinning off its GEP in a tax-efficient manner could prove tricky.
3. Invest organically (or collaboratively) in oncology and biosimilars
Finally, in order to improve shareholder value, Pfizer may consider concentrating its organic growth efforts on what I suspect are its two most-promising therapeutic areas of focus: oncology and biosimilars.
Pfizer is already realizing benefits from metastatic breast-cancer drug Ibrance, which was approved in February 2015. Sales of Ibrance totaled $723 million in 2015, and based on its Q4 sales of $315 million, appears well on its way to pushing for up to $1.5 billion in total sales in 2016. Assuming Ibrance can expand its label, it very well could grow into a $3 billion to $4 billion per year drug.
It's also invested heavily into avelumab, a cancer immunotherapy being developed with Merck KGaA (NASDAQOTH:MKGAY). Pfizer wound up parting with $850 million in upfront cash, promised up to $2 billion in various milestone payments, and agreed to a co-promotion deal for Xalkori in order to be part of avelumab's development. But if the cancer immunotherapy market has demonstrated anything, it's that there's potentially tens of billions of dollars of opportunity waiting to be seized by effective immunotherapies.
Biosimilars, or copycat versions of biologic drugs, could transform into a multi-billion dollar business for drugmakers like Pfizer. Offering biologic drugs at 10% to 50% cost to branded therapies could help Pfizer secure new revenue streams. Of course, it remains to be seen how much of Pfizer's existing product portfolio could eventually become subject to biosimilar competition, as well.
I suspect that Pfizer may choose all three approaches to grow shareholder value as opposed to just one or two, but we should know a lot more after the company reports its first-quarter earnings results in a few more weeks, and we hear from CEO Ian Read and the company's management team.