Is Allergan's price tag really worth it?
Pfizer and the Botox-maker are nearing a deal that could value Allergan at $380 a share, or about $200 billion including debt, according to people familiar with the matter. That's not quite as high as the $400-a-share some analysts said would be necessary to seal a merger agreement. Still, the purchase would rank among the pricier of the recent big deals in pharma. It would also be Pfizer's most expensive takeover in more than a decade, and the largest in the industry by dollar amount.
Drugmakers have gotten away with -- and even been rewarded for -- paying rich multiples on takeovers in the last couple of years. That's largely because many of the transactions have been set up as inversions, which allow acquirers to shift their legal headquarters to a country with a lower corporate tax rate. Other times, the strategic appeal and potential cost savings are seen as so great that it's worth the risk of overpaying.
In the case of a Pfizer purchase of Dublin-domiciled Allergan, the tax savings should be there, assuming the U.S. Treasury doesn't stand in the way (which as of now seems to be the case -- more on that later). But strategically, the high price is hard to justify.
Buying Allergan would help Pfizer prime its established products unit for a spinoff. That's fine, but what Pfizer really needs are fast-growing products to help replace its own fading blockbusters. Allergan has a few such drugs, but as my colleague Max Nisen has noted, CEO Brent Saunders (the reported future leader of a Pfizer-Allergan combo) is better known for avoiding the kind of R&D spending that's likely necessary for future innovation.
The company formerly known as Actavis acquired Allergan in March and took its name. That acquisition is the primary driver behind projected revenue gains of about 40 percent this year. After that, Allergan's sales growth looks less impressive: a decline in 2016, and roughly 8 percent boosts in the next two years. Nothing to sneeze at, but not exactly the kind of thing that will solve Pfizer's woes.
David Pyott, the CEO of Allergan before the company sold itself to Actavis last year, sums it up pretty well:
You can't say there is a great opportunity to put two businesses together that will create an innovative and more complete portfolio of products.
There are some benefits to be had beyond lower taxes. But using a Bloomberg Intelligence estimate of about $3 billion in synergies, the deal won't be accretive to Pfizer's earnings until at least 2018 and even then, probably only modestly so, at best.
Adding cash to the deal terms would help, but doing so could put the inversion afoul of the stricter guidelines already proposed by the Treasury last September. CNBC is reporting Pfizer's offer is all stock. Structuring a deal with Allergan as the buyer -- something the companies are considering, according to a Wall Street Journal report late Thursday -- could help the deal pass muster.
To really make the deal appealing, Pfizer needs to capitalize on the benefits of an Irish address. That includes not just a lower tax rate, but access to overseas cash and earnings stripping. The latter is a maneuver used by inverted companies to effectively shift earnings to lower-tax countries and reduce the amount of income taxed at the U.S. rate of 35 percent, the highest in the industrialized world. These advantages are huge -- if it works.
The U.S. Treasury Department is planning to build on efforts last year to deter inversions with new guidance this week. It could target earnings stripping.
The general consensus among analysts seems to be that whatever steps the Treasury takes to try to curtail inversions won't be enough to dissuade Pfizer and Allergan. That could be true, but it's hard to really know just what companies are counting on to justify the prices of these inversion deals. Remember AbbVie and Shire? Right up until that $55 billion merger went bust, many said the deal would survive tougher Treasury guidelines.
Pfizer and Allergan aren't necessarily destined for the same fate, but investors should at least be prepared to think about whether the deal still makes as much sense if it's not an inversion. Given that Pfizer's stock is down about 9 percent since news of its possible takeover of Allergan surfaced, maybe some are already thinking the answer is no.
Update: Adds the latest details about the deal in the ninth paragraph, as reported by the Wall Street Journal.
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Brooke Sutherland in New York at firstname.lastname@example.org