On November 23, 2015, pharmaceutical companies Allergan (NYSE: AGN) and Pfizer (NYSE: PFE) announced that the Board of Directors for both companies had approved an all-stock merger agreement between the two companies. Under the merger’s terms, Allergan shareholders will receive 11.3 shares of the new company for each Allergan share held while Pfizer shareholders will receive 1 share of the new company for each Pfizer share held. Allergan shareholders will own approximately 44% of the new company (4.3 billion shares), with Pfizer shareholders owning the remaining 56% (5.9 billion shares). As part of the agreement Allergan plans to divest its generic drug business to Teva Pharmaceutical Industries (TEVA), with the divestiture expected to close in 1H16. Current Pfizer CEO Ian Read will serve as Chairman and CEO of the new company, with current Allergan CEO taking on the role of President and Chief Operating Officer. The new company will be named Pfizer PLC and trade under the PFE ticker symbol on the NYSE. The merger is not expected to close until the second half of 2016, pending shareholder and regulatory approval in the United States and Europe. The two companies agreed to a merger breakup fee of $3.5 billion with two special conditions: adverse changes in the law, outside the companies’ control, would reduce the breakup fee to $400 million; and if shareholders of either company unilaterally vote down the merger, that company would have to pay $1.5 billion.
Based on Pfizer’s closing share price of $32.18 on November 20, 2015, the merger agreement values Allergan at roughly $160 billion, or $363.63 per share, with the inclusion of debt. This represents a premium of about 16% over Allergan’s share price of $312.46 on 11/20/2015.
Initial reaction to the merger was negative with some analysts citing concerns that Pfizer’s lackluster financial performance could weigh down Allergan shares over the next 12 months while the merger goes through, and expressing their dislike over the all-share, no cash component of the merger. Pfizer’s annual revenue has been shrinking at an average rate of 6% per year from 2010 to 2015. Additionally, some Allergan shareholders believe Allergan should have been valued at least 10% higher, at close to $400 per share, to reflect their product pipeline and revenue growth potential.
Immediately after the merger announcement, Allergan closed down 3.4% at $301.72 per share while Pfizer closed down 2.6% at $31.33. Pfizer shareholders voiced concerns that the 16% premium for Allergan was too high since Allergan’s growth was already factored into its lofty share price, and that Pfizer might be overpaying for growth from acquisitions, something Pfizer management has been accused of doing in past mergers.
Later, after analyst upgrades, Allergan shares rebounded later in the week, up 6% to $319.76 on 11/27/2015, with Pfizer shares also trading up 4.7% to $32.81 on 11/27/15.
After the merger, Pfizer PLC (the new company) will relocate its tax domicile from New York to Ireland, where Allergan is based, in what is seen as a tax inversion that will lower the new company’s effective tax rate from 25% to approximately 18%. Analysts estimate the company will save about $1.2 billion in taxes in FY2017, its first full year as a combined company. Since 2014, Medtronic (MDT), Shire (SHPG), Perrigo (PRGO), Jazz Pharmaceuticals (JAZZ) and Horizon Pharma (HZNP) have all moved their tax domiciles to Ireland. Tax inversions have come under much scrutiny by the U.S. government since they lowers tax revenue. President Barack Obama, Republican presidential nominee Donald Trump and Democrat presidential nominees Hilary Clinton and Bernie Sanders all immediately spoke out against the potential merger for this reason. Congress was also concerned over the merger leading to massive job losses, the potential relocation of valuable drug research and development talent from the U.S. to Ireland, a reduction in competition within the pharma industry, and the continued upward trajectory of the price of branded drugs which have increased about 125% on average since 2008.
The proposed merger will create the largest pharmaceutical company in the world with over $63.5 billion in annual sales (2015 estimate). Pfizer PLC will have a pipeline of over 100 mid to late stage treatments in addition to its large existing portfolio. Management expects to spend $8 billion to $9 billion annually on research and development across about 40 R&D sites around the world. The merger is expected to generate $2 billion in operational synergies through 2018, well below analyst estimates of $4 billion in synergy savings; but the lower figure reflects the non-overlapping nature of the operating segments at each company which is touted as a major factor in favor of the merger.
The merger should boost Allergan’s high growth rate as it leverages Pfizer’s vast drug distribution, sales and marketing network to boost Allergan products in new and existing markets. Additionally, the tax inversion will help lower expenses so the new company can expect a slight boost to profit margins by a few percentage points, from the low single to the mid-single digits range.
For now, Pfizer management has postponed any talk of splitting the new company into two separate entities – one focused on new branded drugs protected by patents, the other focused on older drugs with no exclusivity until 2018 at the latest. This postponement gives management time to rationalize its combined drug portfolio, realize the synergy benefits of the merger, and identify an appropriate strategic path to capitalizing on the split. This delay will also give the new company time to factor in possible effects from changing healthcare and health insurance reform laws in the United States.
If the merger goes through as expected. The new Pfizer PLC is expected to have operating cash flow of over $25 billion by 2018, which management plans to use for dividends and share repurchases to return value to shareholders. The addition of Allergan to Pfizer’s earnings per share is expected to be neutral in 2017, accretive in 2018, over 10% accretive in 2019 and close to 20% accretive in 2020 – so shareholders can expect healthy dividend growth since management plans to pay a dividend that is approximately 50% of earnings per share.
While the merger has its pros and cons, regulatory hurdles could de-rail the combination. However, the relatively small termination fee for a merger this size reflects confidence at both companies that they will ultimately win approval for the deal.