Pfizer (PFE) needs to grow, but the Obama administration just scotched its plan to merge with a smaller, Irish-based drugmaker and thereby lower its tax burden. So, what's its next step? Acquire other companies, although likely U.S. ones, and thus avoid controversial tax-favored deals.
On Wednesday, Pfizer, the largest U.S. pharmaceutical company, droppedits $160 billion planned union with rival Allergan (AGN) after the Treasury Dept. torpedoed their tax arrangement. The merger involved Pfizer technically relocating to lower-taxed Ireland, a technique called an inversion, which is trendy among many big U.S. companies.
While Pfizer hasn't indicated yet what it intends to do next, it's widely expected to get back in the buying game sooner rather than later. Chief Executive Ian Reed said in a statement, after the Allergan bid collapsed, that Pfizer viewed "the potential combination as an accelerator of existing strategies." Aside from providing a tax break, Allergan would have contributed wrinkle remover Botox to Pfizer's inventory.
Then, in a Wall Street Journal op-ed piece, Reed made clear that Treasury's action rendered any more overseas acquisitions all but impossible, at least for now. If the rules can be changed retroactively, he wrote, "how can any U.S. company engage in the long-term investment planning necessary to compete?"
Boasting a robust balance sheet and minimal debt, Pfizer has the juice to buy anything it wants and is positioning itself for more expansion. In that spirit, the pharma giant is mulling spinning off older, less-profitable drugs into another company. It previously has sold off noncore businesses such as infant nutrition and animal health. Such divestitures give it more flexibility to acquire other, more promising partners.
Pfizer has a history of serial acquisitions, which for drug companies is an easy way to get new products without the costly headaches of research and development and seeking U.S. Food and Drug Administration regulatory approval. In 2009, Pfizer bought Wyeth, maker of a meningitis remedy, and in 2015 Hospira, which produces cheaper versions of biotech drugs.
In 2014, it tried to buy British rival AstraZeneca (AZN) for $118 billion but called off the effort after the target's board rejected Pfizer's advances.
In recent years, as a cost savings, Pfizer has pared its own R&D budget, although in fairness the firm does have a promising pipeline that includes cancer therapies that seek to enlist the body's immune system to fight tumors. And Pfizer is known as shareholder-friendly, with a fat dividend yielding almost 4 percent annually.
"The larger a company gets, the harder it is to demonstrate growth -- it's just the law of numbers," PricewaterhouseCoopers consultant Dimitri Drone told The New York Times, in reference to Pfizer. "When you're big, you keep needing to demonstrate that you can hold your own."
Meanwhile, Pfizer must reverse several vexing problems, which a shiny new acquisition might help with. The company's revenue has slumped to $49 billion last year from $68 billion in 2010. In 2013, its blockbuster Lipitor went off patent, depriving Pfizer of the lucrative exclusive rights to the anti-cholesterol pill. And next year, another cash cow gets butchered: Erectile dysfunction drug Viagra loses its patent protection.
To Morningstar analyst Damien Conover, Pfizer faces an abundance of risks from "generic competition, an increasingly stringent FDA and stronger managed care negotiating power." In a research note, Conover wrote that "several of Pfizer's pipeline drugs are reaching market behind competitors," which may result in "commercial failure."
That said, investors didn't exactly applaud the Allergan deal, perhaps in recognition of the anger over inversions from President Barack Obama and several candidates running to succeed him. Pfizer stock fell after the deal announcement in November and, with this week's news that the transaction was dead, rallied.
Certainly, should the political landscape shift next year and a Republican wins the White House, Pfizer could resume its international merger quests. GOP contenders look favorably on changing IRS rules that force American multinationals to harbor vast earnings overseas. The companies sequester the money offshore, rather than repatriate it to the U.S. where it faces higher taxation.
That's why, in the meantime, analysts expect Pfizer to focus on smaller acquisition targets at home.