White House tax moves sink massive Pfizer-Allergan merger

NEW YORK — Moves by the Obama administration to protect the US tax base torpedoed the massive $160 billion merger of drug giants Pfizer and Allergan Wednesday.

Pfizer said the deal announced last year, which would have seen it move its corporate domicile to Allergan's Ireland headquarters to slash its US tax bill, was cancelled due to new tax rules directly aimed at halting such "inversion" takeovers.

The companies said they were terminating the merger "by mutual agreement" just hours after President Barack Obama labelled such deals "insidious".

‘Gaming the system’

While not mentioning the Pfizer-Allergan inversion, the largest such deal announced yet, Obama on Tuesday called tax avoidance using legal loopholes "a big global problem".

He said wealthy individuals and corporations are "gaming the system" and are not "paying their fair share" while benefitting from the country's skilled workforce, infrastructure, and rule of law.

"They effectively renounce their citizenship. They declare that they're based somewhere else, thereby getting all the rewards of being an American company without fulfilling the responsibilities to pay their taxes the way everybody else is supposed to pay them," he said.

The decision to cancel the merger "was driven by the actions announced by the US Department of Treasury on April 4, 2016, which the companies concluded qualified as an 'Adverse Tax Law Change' under the merger agreement," Pfizer said in a statement.

The deal, in which Pfizer was to buy Allergan but then move its corporate administrative base into Allergan's Dublin headquarters to benefit from Ireland's ultra-low business tax rates, would have created the world's largest pharmaceutical company.

At least two dozen inversion mergers have been announced over the past four years, with Ireland the preferred destination for US companies relocating their legal domicile offshore. Other destinations have included England, Bermuda and Canada.

For example, in 2014 Miami-based Burger King's Brazilian owners 3G Capital merged the fast food giant with smaller Canadian coffee shop chain Tim Hortons in order to move the corporate address to Canada for tax savings. The main operations remained in Miami.

While US companies say the US corporate tax rate is uncompetitively high, the US Treasury has repeatedly warned that such deals are eating away at an important source of government revenues.

The Pfizer deal was particularly targeted by the new Treasury rules because Allergan itself had been built on previous inversion deals. In 2012, the US drugmaker Watson Pharmaceuticals took over Swiss company Actavis but took on Actavis' identity and offshore location.

In 2013, Actavis took over Ireland-based Warner Chilcott in an all-stock deal and moved its administrative headquarters to Dublin, where the corporate tax rate is 12.5 per cent, compared to a maximum rate of 35 per cent in the United States.

In 2014, Actavis took over US drug maker Forest Laboratories, reaping more tax benefits. And then last year Actavis merged with Allergan, the US maker of Botox, in a $66 billion deal that also cited huge tax savings.

Both Allergan and Pfizer expressed disappointment that their merger would not go ahead.

"Pfizer approached this transaction from a position of strength and viewed the potential combination as an accelerator of existing strategies," said company Chairman and Chief Executive Officer Ian Read.

Pfizer agreed to pay Allergan $150 million to reimburse its expenses linked to the planned merger.

Allergan Chief Executive Officer Brent Saunders said in a separate statement that while he is "disappointed" that the merger will not proceed, his company is nevertheless "poised to deliver strong, sustainable growth built on a set of powerful attributes".

Obama called global tax avoidance a "huge problem" and urged Congress to take action to stop US companies from tax-avoiding corporate "inversions", which lower companies tax bills by redomiciling overseas.

"While the Treasury Department's actions will make it more difficult... to exploit this particular corporate inversions loophole, only Congress can close it for good," Obama said.

Several US presidential candidates, including Republican Donald Trump and Democrats Hillary Clinton and Bernie Sanders, have seized on the issue in their campaigns.

"We have so many companies leaving, it is disgraceful,"  Trump told reporters as he greeted voters in Waukesha, Wisconsin on Tuesday. Clinton and Sanders both expressed support for Treasury's plan.

Besides Pfizer-Allergan, other pending inversion deals that have not yet closed include the proposed $16.5 billion merger of Johnson Controls Inc. with Ireland-based Tyco International Plc., Waste Connections Inc.'s  $2.67 billion deal with Canada's Progressive Waste Solutions Ltd., and IHS Inc.'s $13 billion acquisition of London-based Markit Ltd.

In all these cases, the shares of the target companies fell only slightly. Johnson Controls and Tyco said they would respond after conducting a review of the new rules.

Waste Connections and Progressive Waste Solutions said they expected the rules would impact less than 3 per cent of the combined adjusted free cash flow in their first year after the deal.

IHS and Markit said they believed the rules would not affect their adjusted effective tax rate guidance of a low to mid-twenties percentage range.

Three-year rule

Under previous rules which still apply, Allergan shareholders needed to own at least 40 per cent of the combined company for the two companies to enjoy the full tax benefits of an inversion, and more than 20 per cent to have any inversion benefit at all.

But a new “three-year-look-back rule” issued by the Treasury on Monday made this much harder for Allergan, and appeared to take aim directly at it because of how the company was put together.

The new rule does not allow stock accumulated through a foreign company's US deals in the last three years to count towards the book value needed to meet the inversion threshold.

This weighed on Allergan heavily because of its significant deals in this timeframe. These include the $66 billion merger of Allergan and Actavis Plc., the $25 billion purchase of Forest Laboratories and the $5 billion takeover of Warner Chilcott.

"The serial acquisition portion of the regulations will cause Pfizer to be treated as an 'expatriated entity' [under the terms of its existing deal with Allergan]," Robert Willens, a  corporate tax and accounting analyst, wrote in a note.

Shedding generics

In a second change to the rules, the Treasury also said it would seek to limit a practice known as earnings stripping that is often undertaken following, but not limited to, an inversion. The new Treasury rules would restrict related-party debt for US subsidiaries in dealings that do not finance new investment in the United States.

Without Allergan's new, fast-growing medicines, Pfizer may need to look for other companies with attractive products, such as US drugmakers Biogen Inc., Regeneron Pharmaceuticals Inc. and AbbVie Inc., said Raghuram Selvaraju, managing director of brokerage H.C. Wainwright.

Pfizer had planned to make a decision by 2016 whether to split off its hundreds of generic medicines, but delayed the decision until 2019 after announcing its merger with Allergan. Morningstar analyst Damien Conover had said the decision could be moved to late 2017 or 2018 if the deal with Allergan collapsed.

Pfizer, which announced the deal in November, had said its tax rate would drop to about 17 or 18 per cent after the deal, from around 25 per cent. That would have represented more than $1 billion in annual cost savings.

The deal's collapse is also a blow to the investment banks involved. 

Guggenheim Partners LLC, Goldman Sachs Group Inc., Centerview Partners Holdings LLC and Moelis & Co.  stood to share $94 million in fees advising Pfizer had the deal closed, while Allergan would have paid its advisors, JPMorgan Chase & Co. and Morgan Stanley, $142 million in total, according to the latest estimates by Freeman & Co. LLC.

Bankers may now get paid only 10 per cent of these amounts, according to Freeman.

This is not the first time a tightening of the US inversion rules have caused a merger to unravel. US pharmaceutical company AbbVie abandoned its $55 billion takeover of Ireland-domiciled peer Shire Plc after the Obama administration cracked down on inversions in 2014. AbbVie had to pay Shire a $1.6 billion break-up fee.