Tuesday 15 October 2019

Pfizer faces future as hope of inversion ends

With the US Treasury's new tax rules having scuppered its merger with Allergan, what does the future now hold for Pfizer - which employs 3,300 people in this country and several of whose major drugs are coming off patent?

(Stock image)
(Stock image)

Dan White

It was a precisely-targeted financial drone strike. The new tax rules published on Monday by the US Treasury were aimed squarely at the $160bn Allergan/Pfizer merger, which would have deprived Uncle Sam of billions of dollars of tax revenue.

President Obama and his Treasury Secretary Jack Lew had Ireland Inc firmly in their sights when they gave the order to fire last week. Acquirer Pfizer quickly announced that it was walking away from the deal, which could have yielded it annual tax savings of up to $1.3bn. Direct hit, target destroyed, mission accomplished.

So why do we in Ireland find ourselves in the Obama administration's sights?

The US has one of the highest company tax rates in the world at 35pc. This compares to the Irish company tax rate of 12.5pc. Even more onerous is the fact that US companies are liable for tax on their worldwide income, while companies registered in most other countries, including Irish companies, only pay tax on the profits made in that country.

America's extremely high company tax rate and the fact that US companies are liable for tax on their global income has created all manner of distortions. Washington-based advocacy group Citizens for Tax Justice calculates that US companies are sitting on up to $2.4 trillion of unrepatriated foreign profits (the equivalent of more than 12 times Irish GNP). They prefer to leave these profits pile up overseas, another $200bn in 2015, rather than bring them home and pay US tax on them.

Apple, which employs over 4,000 people in this country, is the biggest hoarder of overseas profits with CTJ estimating that it had $200bn of unrepatriated profits stashed away at the end of 2015, up $42bn over the previous 12 months. Pfizer was in second place with CTJ estimating its total unrepatriated profits at $193bn at the end of 2015, an $18bn increase on the 2014 figure.

Unrepatriated profits is only one of the distortions caused by the extremely high US company tax rate. The other major distortion is so-called "tax inversions", where a smaller overseas company purchases a US company and the enlarged company switches its tax domicile to that of the acquiring company.

With much lower company tax rates in other countries and not just Ireland - the UK company tax rare will fall to jut 17pc by 2020 - many US companies have been "taken over" by smaller overseas companies in recent years and moved their tax domicile offshore. This is despite the fact that the vast bulk of their operations and senior management remain stateside.

Although the first tax inversions took place as far back as the 1980s, the phenomenon has gathered pace in recent years with M&A website Dealogic recording 40 major tax inversions since 2012. This is despite two previous attempts by the Obama administration to crack down on inversions, one in 2014 and a second effort last year.

Even by the standards of recent mega-deals, the Pfizer/Allergan tax inversion was a whopper - at $160bn it would have been more than twice as big as what had previously been the largest transaction. Almost certainly too large. Faced with the prospect of most of the US pharmaceutical industry fleeing the American tax system and with its previous more modest efforts to rein in inversions having failed, the Obama administration sent in the drones.

Under the new rules to qualify for a tax inversion, not alone will shareholders of the acquiring company have to own at least 40pc of the merged company but, and here's the twist, any shares issued by the acquiring company in the previous three years will be disregarded when calculating this 40pc threshold.

This look-back provision prevents foreign-domiciled companies artificially "bulking up" in order to meet the 40pc limit. If this means that the new rules look like they were drawn up to specifically target so-called "serial inverters" such as Allergan - an Irish-domiciled company that operates out of a Boston suburb and was largely created by three previous inversion deals over the past three years - it's probably because they were.

Just for good measure the new rules will make it extremely difficult for overseas companies acquiring US companies to engage in "earnings stripping" by forcing the American company to pay excessive interest on loans from its overseas parent.

We in Ireland are in the eye of the tax inversion storm. While Ireland hasn't been the only jurisdiction to which US companies have relocated their tax domicile, several major inversions have also gone to the UK and the Netherlands, we have been getting more than our fair share with six of the top 10 inversions recorded by Dealogic involving Irish-domiciled companies.

The timing of the announcement of the new rules was curious. On the face of it the two events were separate but the US Treasury unveiled the new inversion rules on the very same day that the Panama Papers, detailing tax avoidance, tax evasion and money laundering on a massive scale by political leaders and other well-connected individuals and organisations, were leaked.

Indeed, the President himself appeared to link the Panama Papers and tax inversions in his remarks announcing the new rules, saying that "tax evasion is a big global problem", describing inversions as an "insidious tax loophole" and accusing inverting companies of "gaming the system".

While it has yet to be seen if the new rules will stamp out inversions altogether, it seems reasonable to assume that we won't be seeing deals on the scale of the Pfizer/Allergan merger again any time soon. Which leaves Pfizer facing a major strategic problem.

The collapse of the Allergan deal is the second time in less than two years that Pfizer chairman Ian Read has failed to consummate an inversion deal. In 2014, Pfizer unsuccessfully attempted to acquire UK pharmaceutical company AstraZeneca in a transaction that would have been worth up to £69bn. That deal foundered amid concerns over the security of AstraZeneca's UK jobs, particularly in research and development.

In common with most of the other major pharmaceutical companies, Pfizer is confronted by the "patent cliff" as many of its best-selling drugs and remedies come off patent - and face competition from much cheaper generics.

The patent on its anti-cholesterol drug Lipitor (with total sales of almost $125bn, the best-selling patented drug in pharmaceutical history) expired in 2011 - while the patent on its best-selling erectile dysfunction drug Viagra, most of which is manufactured in Ringaskiddy, Co Cork, expired in most European countries in 2013 and will expire in the USA in 2019. For drug manufacturers and patients alike the consequences of a drug coming off patent are dramatic. For the manufacturer, the end of patent protection typically means a drop in sales of up to 90pc. Annual sales of the Pfizer drug Protonix, which came off patent in 2010, fell from more than $1.9bn in 2007 to just $480m three years later.

The pharmaceutical companies' loss is patients' gain. I have some personal experience of the patent cliff. When I was first prescribed a medication in 2011 I was paying €32 a month for the Pfizer-branded product - not, I hasten to add, Viagra! Five years later I am paying €18 a month for the chemically-identical generic.

So what does Mr Read do now? The good news for the embattled Pfizer boss is that the Allergan deal was deeply unpopular with investors who felt that Pfizer was paying over the odds for the Botox manufacturer. When news of the collapse of the deal broke the Allergan share price fell by almost 20pc while the Pfizer share price actually rose by 3pc.

This buys Mr Read some time. With Allergan now off the agenda, Pfizer will probably press ahead with previously-announced plans to split its research-led branded pharmaceutical businesses from its generic arm, something that could now happen before the end of the year.

"We plan to make a decision about whether to pursue a potential separation of our innovative and established businesses by no later than the end of 2016", said Mr Read.

However, hiving off the generics business will be no more than a quick fix for Pfizer. Mr Read will have to do more, probably a major acquisition, if he is to keep investors happy.

While last week's rule change doesn't completely block the inversion route, it does dramatically reduce the number of likely candidates. In practice there are now probably only two companies that fit the bill for Pfizer, AstraZeneca and the other major British pharmaceutical company GlaxoSmithKline. AstraZeneca has already rebuffed Pfizer while many of the factors that helped scupper the proposed AstraZeneca takeover, not least the security of British jobs, would also apply if Pfizer bid for GSK.

At the very least Pfizer will have to pay top dollar if it is to acquire either of these two companies. With the next US administration, regardless of which party wins the White House and Congress in November, likely to start cutting US headline company tax rates, would the tax savings still be sufficient to justify such a high price tag?

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