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Does it make sense for Pfizer to buy Allergan? What the wags say…

pic thx to pictures of money flickr creative commons [1]

pic thx to pictures of money flickr creative commons

The likelihood that Pfizer would eye another huge deal – and that Allergan was a potential target –  has been simmering for weeks. After all, Pfizer execs have hardly made it a secret that, after failing to win control of AstraZeneca last year, they remain interested in another big drug maker that would not only jumpstart growth, but provide a tax benefit.

Specifically, Pfizer is interested in pursuing a tax inversion. This type of deal allows a US company to buy a foreign company and reincorporate headquarters overseas where corporate taxes are lower. Drug makers, in particular, have cherished inversions, because the acquiring company can reduce taxes by adding debt to its US unit and shifting profits overseas. Allergan is domiciled in Ireland, by the way.

But Pfizer has few choices. Besides AstraZeneca, the short list includes GlaxoSmithKline and Shire, as well as Allergan. But another run at AstraZeneca is unlikely, while Glaxo and Shire insist on remaining independent. Allergan, on the other hand, is run by Brent Saunders, who enjoys a good deal, having combined Actavis and Allergan this year. And Allergan confirmed that “friendly talks” are under way.

As with every potential combination, however, there are questions. Will a tax inversion – which prompted the White House to tighten rules last year – invite another round of regulations in order to further discourage such deals? Would a deal accelerate Pfizer plans to split into separate entities selling brand name and generic drugs? And who would run a merged company – does Saunders stay or go?

Here’s what some of the wags are saying:

A merger would be “a comparatively low-risk transaction,” write Sanford Bernstein analysts Tim Anderson and Ronny Gal in an investor note. “Allergan is (mostly) a US company operating mainly in the primary-care markets which Pfizer understands well. The two organizations are geographically close, and the post-merger integration would therefore be easier than a transatlantic deal.”

We should note that while Pfizer has registered gains with some newer drugs, its overall revenue has been declining over the past few years (see page 16 [2]). The slump reflects the loss of patent protection on big-selling drugs, which is what spurred Pfizer execs to pursue AstraZeneca. By comparison, Allergan has some big moneymakers, notably the Botox wrinkle treatment.

In his own note, Credit Suisse analyst Vamil Divan agrees a deal would make sense for Pfizer, although he points out a combination would not bolster its generic business, since Allergan recently agreed to sell most of its generic products to Teva Pharmaceuticals. An open question is whether Pfizer would try to break the deal to bolster its generic unit in advance of splitting itself apart or keep the cash.

Most likely, Pfizer would let the sale to Teva go through, since disrupting the deal would likely make it more difficult to integrate its operations with Allergan, according to the Bernstein analysts. Another rationale is simply that Pfizer is unlikely to want to run a new company that, in part, relies on filing patent challenges to generate revenue growth.

As for tax inversions, Nomura Securities analyst Shibani Malhotra reminds us the US Department of Treasury proposed [3] that shareholders of an acquired company must own more than 40 percent of the combined company in order to avoid any negative tax consequences. But this hasn’t been implemented yet, and so Pfizer execs recently said they prefer to get any deal done before a new Congress takes office in 2017. The proposal also requires Pfizer to pay out a certain amount of stock to close a deal. Given the size of its market capitalization, Pfizer has few choices besides Allergan to meet the criteria.

“Given the discussions in Washington, DC, last year when Pfizer attempted to acquire AstraZeneca, we assume political rhetoric around inversions may flare up again now,” writes Divan. “It will be interesting to monitor any near-term commentary from the Obama administration, the US Treasury and/or from the leading [Presidential] candidates to see how they react.. and how that might impact the likelihood of a deal being completed.”

And who would run a combined company?

A merger could allow Pfizer to announce succession plans for Chief Executive Ian Read, 62. Saunders is 45 and, given his recent track record [4], this is not surprising.. Over the past two-plus years, he sold Bausch + Lomb for $8.7 billion to Valeant Pharmaceuticals and then took the top job at Forest Laboratories, which he sold to Actavis for $25 billion. He then ran the combined company before acquiring Allergan.

By purchasing Allergan, the deal would “resolve a question for Pfizer shareholders,” writes Leerink analyst Seamus Fernandez. It would lay out a transition plan for Saunders to run Pfizer,, “a role for which we believe Brent Saunders would be well suited.”