Pfizer is leaning toward walking away from its proposed megamerger with Allergan as new US regulations put more pressure on the deal, Reuters reported on Tuesday, citing an unnamed source.
The $160 billion deal was pitched as a way to help Pfizer cut its tax bill by relocating its domicile to Ireland, where Allergan is based. The tax rate for corporations in Ireland is 12.5%, far less than the US rate.
Because the move can be seen as fleeing the US, tax inversions are not particularly politically popular. When the deal was announced in November, presidential candidates Sen. Bernie Sanders of Vermont and Donald Trump were among many who took a stance against it.
The government can discourage inversions by eliminating some of their economic benefits. One practice the Treasury on Monday said it would target is called earnings stripping, a way of jacking up interest payments to lower tax bills.
Pfizer’s lawyers have presented ways to salvage the deal in light of the Treasury Department’s new measures, but the company did not seem inclined to pursue the megamerger, according to Reuters’ source.
“Pfizer is aware that the Treasury will keep ruling against any solution it can come up with,” the source told Reuters.
On Tuesday, US President Barack Obama spoke out against tax inversions, and shares of Allergan dropped by more than 16%.
Also on Tuesday, Bloomberg reported that Pfizer was scrambling to save the deal, and could either challenge the US Treasury Department’s new rules or renegotiate the price.
Pfizer has said that it would review the newest actions and declined “to speculate on any potential impact” until it was done with that.
This isn’t the first time the Treasury has tried to squash a tax-inverting merger. In 2014, AbbVie called off its inversion deal with Shire after the Treasury announced executive moves to attempt to curb inversions.
Maybe not a deal-killer
The changing rules don’t necessarily mean that the deal will be off entirely, according to Sachin Shah, a merger-arbitrage strategist at Albert Fried & Co.
Shah noted that Pfizer CEO Ian Read discussed the potential for tax-rule changes in November, telling CNBC that even “if the benefits from tax weren’t there, I would still try to do the deal.”
“But I suspect the price would be different,” he added.
Shares of Allergan fell more than 16% on Tuesday morning, while shares of Pfizer rose by less than 1%.
The companies have anticipated the potential for the government to make rule changes that could kill the deal.
When they announced the deal in November, Pfizer and Allergan said in their terms that if a deal between Pfizer and Allergan didn’t go through because shareholders of one company objected or because a “superior proposal” appeared, the companies would pay a breakup fee of up to $3.5 billion.
But if the deal were to break because of a change in the law – under which this Treasury move would fall – that termination fee falls to just $400 million.
The Treasury Department didn’t specifically refer to Pfizer’s deal in its statement. US Treasury Secretary Jacob J. Lew said in a release:
Treasury has taken action twice to make it harder for companies to invert. These actions took away some of the economic benefits of inverting and helped slow the pace of these transactions, but we know companies will continue to seek new and creative ways to relocate their tax residence to avoid paying taxes here at home.
Here’s the Treasury’s plan, according to the release:
- Limit inversions by disregarding foreign parent stock attributable to recent inversions or acquisitions of U.S. companies. This will prevent a foreign company (including a recent inverter) that acquires multiple American companies in stock-based transactions from using the resulting increase in size to avoid the current inversion thresholds for a subsequent U.S. acquisition.Address earnings stripping by:
- Targeting transactions that generate large interest deductions by simply increasing related-party debt without financing new investment in the United States. Allowing the IRS on audit to divide debt instruments into part debt and part equity, rather than the current system that generally treats them as wholly one or the other. Facilitating improved due diligence and compliance by requiring certain large corporations to do up-front due diligence and documentation with respect to the characterization of related-party financial instruments as debt. If these requirements are not met, instruments will be treated as equity for tax purposes.