PHARMA DEALS DURING SEPTEMBER 2014
(Part 1 out of 3)

by Roger Davies

This year there have been two major strategic initiatives by big pharma companies: rationalisation of portfolios by trading business areas with one another to consolidate and strengthen market share in specific sectors; and M&A of large companies driven by the need to bolster sales and profits by synergy and tax savings

During September, there were more restructuring and portfolio rationalisation announcements but some big pharma M&A deals are now looking less likely following tax changes announced by the US Treasury.

Company restructuring and portfolio rationalisation

Following restructuring by Pfizer, GSK, Novartis, Lilly and Merck & Co,Bayer has jumped on the portfolio rationalisation bandwagon with its decision to spin off as a separate listed company its Material Science division leaving the focus on Healthcare and Crop Science. The proceeds of the spin off due to be completed in the next 12 to 18 months have been estimated to be around $13 bn similar to the $14.2 bn being paid by Bayer for Merck & Co's consumer health business. In September Bayer completed the divestment of its interventional device business to Boston Scientific for $400 m. In the same way as Abbott spun off its pharma division in early 2013, so Baxterhas announced it will spin off its pharma division into a listed company calledBaxalta with sales of $6 bn.

Both Bayer and Baxter have justified the decision as enabling the management of the spin out companies to be more autonomous and make their own investment decisions whilst having access to capital markets. The question is whether breaking up a conglomerate structure, as Bayer has done, is best for the company and its investors.  In the financial community, the valuation of conglomerate companies is discounted compared to more focused companies because of the perceived lack of synergy between diversified businesses.  So in theory by splitting a conglomerate into separate companies, the overall valuation should increase.  In the case of Bayer there is probably very little synergy between pharmaceuticals and plastics so it was not surprising that the share price of Bayer increased by 6% following the announcement.

Merck KGaA is going in the opposite direction to Bayer and Baxter by consolidating its conglomerate structure. It has announced the purchase of Sigma Aldrich for $17 bn representing a hefty 6.3x sales.  The share price premium was 37% much less than the 53% being paid by Abbvie for Shire.  The acquisition will increase Merck Millipore's product range, sales and geographic coverage and also generate synergy savings of $0.3 bn per year.  Merck Group comprises biopharmaceutical (2013 sales $7.7 bn), consumer health ($0.6 bn), performance materials ($2.1 bn) and laboratory supplies ($3.4 bn + $2.7 bn from Sigma Aldrich). While Merck may not wish to follow Bayer and spin off its performance materials division, there does not seem much point in retaining the consumer health division with less than 5% of sales, a low EBITDA margin and an insignificant player in the OTC market.  Perhaps Merck KGaA will follow the strategy adopted by Merck & Co and divest its consumer health business?

Company acquisitions and tax inversions – the heat is on

This year is going to be a record year for M&A in the pharmaceutical industry with the overall value exceeding the peak year of 2009, assuming that the announced deals are completed and are not stopped by changes in US tax regulations! The tax inversion story whereby a US company buys out a smaller foreign company and then adopts its tax nationality, has been one of the major talking points behind some of the deals that we have reported this year in various Deal Watch issues. This is a US issue predominantly but something that is playing out across the headlines and carrying some considerable deal impact on European companies.

The situation has arisen as the current US tax laws mean that US companies pay US tax when they repatriate profits from other operating units across the world. This is unlike other tax jurisdictions which only charge tax on revenues which arise in that particular territory. Coupled with the fact that US corporate tax can be as much as 35% compared to other territories such as Ireland (12.5%) and the Netherlands (20-25%), it is obvious that there are clear financial incentives for companies to look for tax sparing deals and corporate structures to escape paying US tax.

This is not a recent nor uniquely pharma issue. Tax inversions were happening in the 1990s usually involving countries such as Bermuda e.g. Tyco in 1997 and has included insurance, manufacturing and resource companies. As a result in 2004 Congress enacted new legislation seeking to prevent tax inversions.  Within a few years the tax advisers had found new financial structures to avoid the law and, following the financial crisis, tax inversions substantially increased particularly amongst pharmaceutical companies (see table below).

Year	Acquirer	Target	New company tax domicile
2010	Valeant	Biovail	Canada
2011	Alkermes	Elan	Ireland
2012	Jazz	Azur	Ireland
2013	Liberty Global	Virgin Media	UK
2013	Actavis	Warner Chilcott	Ireland
2013	Perrigo	Elan	Ireland
2014	Endo	Paladin	Ireland
2014	Theravance Biopharma		Cayman Islands
2014	Horizon	Vidarg	Ireland
Pending	Medtronic	Covidien	Ireland
Pending	Mylan	Abbott - generics	Netherlands
Pending	AbbVie	Shire	Jersey
Pending	Burger King	Tim Hortons	Canada

However it was the recent bid made by Pfizer to acquire AstraZeneca which really brought matters to a head with the US government realising that steps needed to be taken to close this particular loophole.

With the political gridlock in Congress blocking or significantly delaying new legislation, the US Treasury announced on 22nd September new tax rules effective immediately to reduce the tax benefits of completed deals and make new inversions more difficult and less financially attractive.  These include blocking loans to access overseas earnings without paying tax, preventing restructuring overseas units and hence accessing cash reserves tax free and the closure of the loophole which allows transfer of cash or property from an overseas subsidiary to a new parent.

These new measures will impact deals that have not yet closed such as Medtronic's $43 bn acquisition of Covidien and AbbVie's $54 bn acquisition of Shire; renegotiation and/or restructuring the deal may be required or the deal may be terminated.  In the latter case, many deals contain sizeable break-up fees such as $850 m in the case of Covidien/Medtronic.  This non closure penalty would not fall due if the deal is vetoed by shareholders or if there is a change in law, but changes in tax guidelines may not be a specified exclusion.  The effect of the announcement of the new tax guidelines has been a temporary decrease in the share prices of the US acquirers and an increase in the workload (and income) of US tax advisers looking for new loopholes.

Fuente: PMLiVE

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