AGN Allergan plc

By Jonathan D. Rockoff, Liz Hoffman and Richard Rubin 

Pfizer Inc. and Allergan PLC terminated their planned $150 billion merger after the Obama administration took aim at the deal that would have moved the biggest drug company in the U.S. to Ireland to lower its taxes.

Pfizer will pay Allergan a breakup fee of $150 million. The breakup fee is relatively small, especially given Pfizer's market value of some $200 billion.

The Wall Street Journal reported Tuesday that Pfizer's board had voted to halt the combination and the New York-based pharmaceutical company then notified Dublin-based Allergan.

The decision to walk away is the latest setback in Pfizer's long-running efforts to overcome what Chief Executive Ian Read has said was the company's competitive disadvantage with foreign rivals that faced significantly lower tax bills.

In addition, the failed deal also hurts Pfizer's plans to break itself up. Company executives have considered splitting the company for years, but they have been deterred by concerns that its businesses may not be large enough to stand alone. The Allergan deal was seen as building the Pfizer's strength in both high-cost, high-growth drugs as well as older, lower-cost drugs.

Wednesday, Pfizer said it would make a decision about any potential separation by the end of 2016. The company also noted that it has "the financial strength and flexibility to pursue attractive business development" and shareholder-friendly moves.

Allergan, for its part, said it was disappointed that the Pfizer deal won't move forward but said its business remains strong. The company also said it believes the Treasury Department's new regulations will have no material effect on the company's stand-alone tax rate, based on a preliminary review.

Allergan added that it would provide an update on its plans to simplify the company's operations when the company reports its first-quarter results on May 10, following the completion of its deal to sell its generics unit to Teva Pharmaceutical Industries Ltd. That cash-and-stock deal was valued at $40.5 billion when announced in July.

In midday trading Wednesday in New York, Allergan shares rose 4.1% to $246.21, while Pfizer shares rose 4.4% to $32.73.

The terminated deal is Pfizer's second failure at buying an overseas company. In 2014, Pfizer had tried but failed to buy British drugmaker AstraZeneca PLC. Afterward, it looked for a new partner, before finally reaching terms with Allergan.

By combining with Ireland-based Allergan, Pfizer could not only cut its tax rate but also get access to the billions of dollars in revenue it was keeping overseas to avoid paying U.S. taxes on top of the taxes it had already paid in foreign countries.

The combination also had nontax benefits for Pfizer, including access to Allergan's portfolio of strongly growing products like antiwrinkle treatment Botox, dry-eye treatment Restasis and new irritable-bowel drug Linzess. A combination also might have paved the way for Pfizer to shed its collection of cash-generating but older slower-growth drugs.

Tax-inversion deals have become commonplace in U.S. corporate deal-making. They also have become a talking point in the U.S. presidential campaign, with certain candidates attacking the uprooting of American companies and departure of tax receipts.

The tie-up between Pfizer and Allergan, the biggest merger announced last year -- the busiest ever for takeovers -- was a particular campaign target. Republican and Democratic presidential candidates have criticized the deal.

President Barack Obama on Tuesday called corporate inversions, in which a U.S. company buys a foreign rival and adopts its lower-tax jurisdiction, one of the "most insidious tax loopholes out there." Companies that have inverted frequently make more acquisitions of U.S. companies to bring them on to their lower-tax platforms.

The problem, Mr. Obama said, isn't that companies are engaging in illegal activity, but what is legal in the first place.

The government had so far been unable to do much to stop corporate inversions, but that clearly changed with Monday's publication of a third installment of proposed rule changes, the stringency of which came as a surprise to many.

In an effort to crack down on what the Treasury Department calls "serial inverters," the new regulations would disregard three years' worth of U.S. acquisitions when determining a foreign company's size under the tax code.

That complicated the finely tuned math that was crucial for inversions like Pfizer's to work. To reap maximum benefits, shareholders of the inverting company should own between 50% and 60% of the combined entity. Between 60% and 80% also works, but the tax perks are diminished, and above 80%, they are lost entirely. So U.S. companies need inversion partners that are at least one-quarter their size, and ideally more like two-thirds.

When the Allergan deal was struck last year, Pfizer's market capitalization was about $200 billion and Allergan's was about $120 billion. Pfizer's shareholders would own 56% of the combined company.

But stripping out three years' worth of deals done by Allergan -- which Treasury certainly would consider a serial inverter -- that math no longer works. Allergan has 395 million shares outstanding.

It has issued about 260 million shares for big deals, including the $25 billion takeover of Forest Laboratories and the $66 billion combination of Actavis and Allergan last year.

Stripping those out leaves about 130 million shares, worth only about $30 billion. Under the current merger ratio, Allergan shareholders' stake in the combined company would likely drop into the high teens.

In other words, in the eyes of Treasury, Allergan would have been too small to be Pfizer's inversion partner.

The White House denied the new rules were targeted at a specific company.

"The Treasury Department is not focused on a specific transaction, it's focused on specific loopholes," White House press secretary Josh Earnest said. The White House declined to address the specific Pfizer and Allergan situation, but Mr. Earnest said the administration would be "pleased" if inversion deals fell through.

Treasury's new three-year rule, though, is less likely to trip up other companies that have been pursuing inversions. Ireland-based Tyco International PLC, the target of Johnson Controls Inc.'s pending inversion, has made few acquisitions in the past three years. The same goes for Canada's Progressive Waste Solutions Ltd., which is Waste Connections Inc.'s intended ticket out of the U.S. tax net.

Write to Jonathan D. Rockoff at Jonathan.Rockoff@wsj.com, Liz Hoffman at liz.hoffman@wsj.com and Richard Rubin at richard.rubin@wsj.com

(END) Dow Jones Newswires

April 06, 2016 12:01 ET (16:01 GMT)

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