The Pfizer-Allergen deal would have been the largest ever healthcare deal and the second largest ever M&A transaction… but it fell through. Rachel Lidgate of Herbert Smith Freehills explains the story…
What was the proposed deal and why did it fail?
The top corporate income tax rate in the US is 35 per cent, which is high compared to most other developed countries. Moreover, while most countries only tax companies on income earned within that country, US-based companies have to pay taxes on their worldwide income.
A “tax inversion” deal is where a foreign company buys shares in a US company so that the US company effectively relocates to where the foreign buyer is based, thereby reducing the rate of tax that the company is required to pay.
Here, US-based Pfizer, one of the world’s largest pharmaceutical companies, was seeking to merge with Ireland-based Allergan, which (due to the low corporation tax rate in Ireland of 12.5 per cent) would have significantly reduced the amount of tax the new, merged entity would have had to pay.
Under US law, Allergan needed to own at least 40 per cent of the shares in the merged company to maximise the tax benefits of the deal. However, a new rule announced by the US Treasury said that if the foreign company has increased in size through mergers or acquisitions with other US companies in the previous three years (as Allergan has), any shares or assets that were obtained or created as a result of those earlier deals will be disregarded when calculating whether the tax benefits apply.
On this basis, instead of Pfizer shareholders owning approximately 56 per cent of the merged entity, they would have ended up with around 80 per cent which would mean that Pfizer would not get the anticipated tax benefits.
Why is it important?
This would have been the largest ever healthcare deal, the second largest ever M&A transaction and the largest ever tax inversion deal.
However, it appears to have been scuppered directly as a result of the intervention of the US government.
There is speculation that the new rule was intended specifically to prevent this deal. The US government has been trying to clamp down on tax inversions, but with limited success to date. This latest action suggests that the US administration is getting tougher in trying to force companies to pay tax in the US (possibly in response to increasing public debate as to whether tax avoidance is wrong in principle).
However, as long as there is such a large disparity between tax rates in the US and in other parts of the world, companies are always going to seek to take whatever steps they can legally to minimize the amount of tax they are required to pay (and arguably, their directors are bound to do so in order to fulfil their duties to shareholders). For this reason, the US president has recently suggested that tax avoidance is a global problem.
What are the consequences and wider implications?
The immediate commercial consequence for Pfizer is the cost of the deal terminating. Similarly the failure of the deal is very bad news for the various investment banks who would have earned huge fees if the deal had completed. Hedge funds which effectively bet on the outcome of mergers and acquisitions will also have suffered losses.
In the longer term it will be interesting to see what Pfizer’s strategy is and whether it aims for another tax inversion deal. Pfizer has repeatedly aimed to enter into such a deal (for example it had previously sought a merger with UK-based AstraZeneca, but that deal foundered in 2014). It is suggested that Pfizer will now look to change strategy, perhaps by splitting off certain parts of its business into a separate company.
More broadly there appears to be a global trend emerging of M&A deals failing due to regulatory issues. Another large (approximately $103bn) acquisition by Honeywell of United Technologies failed in March of this year. United Technologies cited “significant regulatory obstacles” as one of the reasons for not pursuing the proposed deal.
As the article also noted, the proposed takeover of Baker Hughes by Halliburton is currently blocked as the US Department of Justice has challenged it on competition (or “anti-trust”) grounds. Last year a record number of deals were blocked or abandoned as a result of competition issues, including Comcast’s $45bn proposed acquisition of Time Warner Cable.
It is also anticipated that the European Commission is likely to block Three’s proposed £10.25bn takeover of O2 on competition grounds. M&A activity is generally seen as an important indicator of growth, so the failure of these deals sounds warning bells for the world economy.
What will lawyers working in the field be thinking about?
The new US rules may significantly restrict the pool of potential merger partners and prevent tax inversion deals from taking place. Corporate and tax lawyers will be looking at the economic viability of proposed deals where tax inversion is a commercial driver. They will also be thinking creatively about new ways to relocate businesses for tax purposes or otherwise minimise taxes.
Companies attempting merger or acquisition activity will continue to rely on their lawyers to navigate through the global maze of regulations that could be obstacles to the enlargement of their businesses.
Rachel Lidgate is a senior associate at Herbert Smith Freehills