Deals

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Max Nisen is a Bloomberg Gadfly columnist covering biotech, pharma and health care. He previously wrote about management and corporate strategy for Quartz and Business Insider.

Pfizer's last bout with the taxman left it with a black eye. But it's not giving up the fight just yet.

The $209 billion drug giant has made no secret of the fact that it thinks the cumbersome U.S. tax system puts American companies at a disadvantage. It sought not once, but twice, to strike a mega-sized tax inversion that would move its legal address to a country with lower rates, finally finding a willing partner in Allergan. The Treasury Department had other ideas and its regulatory assault on inversions eventually thwarted that plan.

Lost Benefits
Allergan would have helped Pfizer prime its established products unit for a spinoff, but tax savings were perhaps the bigger draw.
Source: Bloomberg, Company Filings
Data reflects Pfizer's projected effective tax rate on adjusted income for 2016 and the mid-point of Pfizer's anticipated rate in the first full year after closing the Allergan deal.

But nobody -- not even the U.S. government apparently -- puts Pfizer in a tax corner. While CEO Ian Read says he's not focused on hunting for inversions right now, he left open the possibility of doing them in the future under a different presidential administration and seemed to be shifting his thoughts to a plan B of how to structure such a deal. On a call last week to discuss Pfizer's first-quarter earnings, Read hinted at the idea of using a much-anticipated breakup as a way to move at least a chunk of the company to a more tax-friendly jurisdiction. Hey, when going big fails and going home isn't appealing, go half-way... right?

It is possible to do an inversion with just a piece of Pfizer. That doesn't mean it's a good idea. It will be complicated and time-consuming. And there is the ever-present possibility that the government changes the rules yet again. Failed inversions haven't been as costly for Pfizer as they have for other companies (AbbVie being a prime example). But it should think carefully about going head to head with the Treasury again.

The idea of a partial inversion or  a "spinversion" (in which a company spins off a part of itself, and then merges that piece with a non-U.S. company) has been bandied about before as a way for large firms to get at least some tax benefits without all of the political ruckus that comes with mega-deals. A mini-Pfizer wouldn't need as big of a partner, which broadens out the pool of possibilities and makes it easier to structure an inversion. But like anything with taxes, it's tricky. 

$160 Billion Gap
Health-care M&A hit at a record last year, but the volume would have been much higher if Pfizer's purchase of Allergan had gone ahead.
Source: Bloomberg

For one, you have to use the right piece of the company. The surviving Pfizer parent would have to wait three years after a spin-off to do an inversion, but the division that's been split off may not have the same timing issues -- as long as the unit is significantly smaller and there's a legitimate business purpose for the breakup, says tax consultant Robert Willens. That spin-co could even potentially do an inversion with a foreign company in conjunction with the breakup, says Laurence Bambino, a tax partner at Shearman & Sterling.

But that mini-Pfizer has to find an absolutely perfectly sized overseas partner so that its shareholders end up with more than 50 percent but less than 60 percent of the newly combined foreign entity. Otherwise, the tax-free nature of the spinoff could be in jeopardy, or the deal could butt up against Treasury rules that make it harder for inverted companies to do things like access overseas cash.  Oh, and the transaction also has to be all stock. All this, before you even think about whether that merger partner makes strategic sense. 

There is a third option. Pfizer could try to do a so-called naked inversion whereby it decides a piece of itself is foreign enough that it doesn't need to do a merger to move abroad. Coffee company D.E. Master Blenders was based in the Netherlands from the get-go when it was separated from Sara Lee in 2012 because it was able to prove substantial business activities in that country. To meet that standard, Pfizer would need to show that at least 25 percent of the spinoff's assets, among other things, were located in a foreign country.  That wouldn't be the easiest thing for a global company of Pfizer's size.

Maybe Read would be better off just focusing on the breakup -- an idea kicked around since 2011 -- without any tax shenanigans. The underlying rationale has always been to set Pfizer's higher-growth, higher-margin new drugs free from its declining established pharmaceuticals business -- and the logic is only getting stronger. Sales at the more grizzled hunk of Pfizer's business (excluding drugs from its acquisition of Hospira) fell in the first quarter, while revenue for newer products soared 23 percent.

Passing the Torch
Pfizer's newer drugs are outperforming its older ones, setting the stage for a potential split.
Source: Bloomberg

Combining the old with the new may be weighing on Pfizer’s valuation. The established business has also already been bulked up for life on its own by last year’s $17 billion acquisition of Hospira.

With the accounting and operational complications of the Allergan deal off the table, a spinoff is just waiting on Read’s go-ahead. Does he really want to muddy the waters by wading back into the inversion?

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. Otherwise, the assets that had been separated would still count toward Pfizer's size for the purposes of determining the ownership breakdown in an inversion -- essentially defeating the whole point of the spinoff. 

  2. And that partner better not have done any major U.S. acquisitions in the last year or the companies will run into the same issues that felled Pfizer-Allergan. 

  3. The company would also have to prove that at least 25 percent of the business' employees worked in the designated country, that those employees made up at least 25 percent of the overall compensation pool and that 25 percent of its income came from customers in that country. So in theory, you could have tons of mini-Pfizer's for each country that it does business in, but that doesn't make a lot of sense because the company benefits from having a global business. 

To contact the authors of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net
Max Nisen in New York at mnisen@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net