Pfizer Inc, Market Cap (as of 23/05/2014): $188.37bn
AstraZeneca PLC, Market Cap (as of 23/05/2014): $91.78bn
In its bid for AstraZeneca, Pfizer, the famous Viagra producer, failed to make a satisfactory offer and turned the potential biggest foreign takeover in UK corporate history into failure. It all happened on May 19 when AstraZeneca PLC Board formally rejected Pfizer’s final proposal of $117bn paid in cash and shares, because of risks and uncertainties brought by this acquisition at the expenses of shareholders. When Ian Read, Pfizer’s Chairman and CEO, approached Lief Johansson, AstraZeneca’s chief executive, in November 2013 with the interest to create the world’s largest pharmaceuticals group, he was confident in his position considering that AstraZeneca’s sales were decreasing due to the loss of old drugs patent protection. For the meeting of the two chief executives in January, the situation had already changed as a range of new promising drugs was starting to emerge from AstraZeneca’s laboratories. By offering £46.61 per share, Pfizer was trying to buy AstraZeneca at its old price, not incorporating the potential growth and, therefore, underpricing it. It seemed straightforward for the board to reject the £46.61 per share proposal, as well as the £50 a share on May 2. The continuous underpricing, judged by AstraZeneca, together with the overall uncertainty characterizing the real drivers of Pfizer bid and political pressure (given the effects that the takeover of Britain’s second largest drug-maker, after GlaxoSmithKline, would mean for jobs and investments) created an adverse environment for Pfizer. In addition, AstraZeneca went on the offensive, announcing a bold 75% growth in sales over the next decade, time needed for the drugs to reach the market. Henceforth, when the final offer of £55, comprising £24.76 in cash (45%) and 1.747 Pfizer shares (55%) per AstraZeneca share, reached AstraZeneca board, it was, once again, rejected.
Pfizer’s efforts to merge with AstraZeneca come at a time when M&A in pharmaceuticals industry is booming. Before analysing further the motivations and the evolution of the deal, it is useful to overview the string of pharmaceutical deals that have been characterizing the healthcare industry since the beginning of 2014. Only a month ago Valeant Pharmaceuticals International Inc. attempted a hostile takeover toward the famous Botox-producer Allergan Inc., teaming up with the activist investor Bill Ackman, founder and CEO of the hedge fund Pershing Square Capital Management LP. The deal would have created another giant in the pharmaceutical industry with a hypothetic capitalization of more than $80bn, able to exploit cost synergies as well as to gain a near-monopolistic position over face-treatments. Not only that, the strategic acquirer started from a favourable position given its initial stake in the target (close to 5%) and the additional 9.7% held by Ackman, that potentially would have eased the negotiations and reduced the likelihood of competing bids. However the Botox-maker, unwilling to cut its high R&D expenses and confident that the $46bn undervalued the company, has formally rejected the offer. To defend from takeover, the target company implemented the “shareholder right plan” (poison pill). i.e. distribution of vote-only shares to pre-existing shareholders if anyone carries its stake beyond the 10% threshold. In this way Allergan hopes to buy enough time to seek a potential “white-knight” such as Sanofi or Johnson&Johnson. Meanwhile in Europe, GlaxoSmithKline PLC and Novartis International AG entered an asset swap, the British pharmaceutical giant sold its oncologic division to Novartis for $16bn dollars, obtaining the former’s vaccine unit for almost $7bn plus royalties. In addition, the European-based companies also reached an agreement for a joint venture (of which GSK holds a 63.5% stake) on OTC products for a business of $10.9bn. Furthermore, Novartis sold its animal health business to Eli Lilly for $5.4bn in cash. These asset trades would allow each group to achieve greater strategic focus in the chosen area rather than being present in each division with weaker positions. At the same time, Bayer acquired the OTC division from Merck&Co for $14.2bn relying on revenues, costs and tax synergies as clarified in our previous article. Earlier in the year, Actavis PLC acquired Forest Laboratories Inc for $25bn, delivering a major payday to target’s second largest shareholder Carl Icahn.
The impression is that all these deals underscore the most extensive effort by drug makers to strengthen their businesses. Competition has forced many to cut costs, reshape research and development expenses, and think about gaining scale via consolidation. Some companies have pursued a focus strategy to concentrate their resources and effort on specific industry segments. In addition, at least for US firms, there is also a tax incentive to acquire foreign companies: they are looking for ways to spend offshore cash without exposing it to high American tax rates.
Back to Pfizer, on the one hand the final offer rejection was supported by some large shareholders confident that Pfizer bid was driven more by tax synergies than it was by strategic and operational ones. On the other hand, other major shareholders believe that the go-it-alone path is not in their best interest and AstraZeneca board has made a gross miscalculation in its quick rejection. The latter point fosters the belief that there may be room for a hostile take-over. Pfizer, however, did not consider a hostile bid and take the offer directly to shareholders who would probably have accepted the £55 per share. The reasons behind this decision could be traced back to the main motivations of Pfizer interest for AstraZeneca. Cost savings and access to the UK company’s promising research pipeline, including new treatments for cancer and diabetes are two important reasons. Nevertheless, a third, and by many believed the main, reason is that the merger would led to a sharp cut in Pfizer’s tax burden through a plan to move the holding company to the UK. Pfizer pays 27 per cent of corporate tax while AstraZeneca pays only 21 per cent so had the deal been successful Pfizer would have been able to lower its average tax rate. Furthermore, its offshore revenues would be shielded from US repatriation taxes and Pfizer has built up one of the largest offshore earnings of any US multinational. Thus, Pfizer’s refusal to go hostile is well explained recurring to its focus on tax savings for the transaction. Indeed, a major aspect of the merge would be the “inversion”, i.e. Pfizer would reincorporate in Britain to save on taxes. Given the recent rise in “inversions” trend, the US Treasury Department has proposed stricter rules starting from Jan 2015 that, if approved, would not permit Pfizer “big escape”. As a consequence of timing squeeze, Pfizer would have to get through regulatory approvals and close the deal before the end of the year to implement the “inversion”, but starting the regulatory approval process without a willing partner is likely to take longer than that. On the other hand, we could also ask a question: why was AstraZeneca so determined to refuse the offer? From the beginning they were very doubtful of what could happen if Pfizer decided to split AstraZeneca, and they thought it would disrupt the business. Mr. Johansson was pretty clear in his rejection affirming that Pfizer with its offers did not manage to capture the expected future growth and potential and that AstraZeneca would be better off by itself than when merged with Pfizer. Overall, they did not appreciate Pfizer’s reasons for the merger and used the tax “inversion” to argue against the deal.
What is next? With the deal off the table at the moment, Mr. Read cannot be so confident and has to seek internal growth. Furthermore, Mr. Read is expected to keep shareholders happy by continuing with the share buyback to avoid the high taxation. If no legal leeway will be found by Pfizer to improve its offer and convince AstraZeneca board in the following days, deal discussion is likely to come back in six months’ time when Pfizer will be allowed under UK takeover rules to renegotiate its offer.
Astra Zeneca was advised by Morgan Stanley, Goldman Sachs and Robey Warshaw while Pfizer was advised by JP Morgan, Bank of America Merrill Lynch and Guggenheim Partners.
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