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Big and bad deals

1 December 2015 By Rob Cox

Pfizer’s $160 billion takeover of Allergan marked a few milestones in the mergers and acquisitions trade. It was the top deal of the year, exceeding Anheuser-Busch InBev’s purchase of SABMiller, and by some measures is the second biggest in history. The all-stock transaction also vaulted the total value of corporate dealmaking in 2015 beyond the record set in 2007, just before the financial crisis shuddered things to a halt.

The pharmaceuticals union also printed another, more dubious superlative as one of the largest deals ever predicated on exploiting global tax loopholes. Without the ability for Pfizer, the larger of the two companies, to back its way into Allergan’s lower-tax Irish domicile, the maker of Viagra, Lyrica and other sweet-sounding compounds would have incinerated some $17 billion of shareholder treasure.

That this high-water mark of M&A is justified by its tax workaround would be sign enough that the two-year boom of extraordinary corporate promiscuity is reaching its logical conclusion. Other, perhaps less perceptible, warning bells are clanging, too, which suggest companies are increasingly pursuing financial engineering to fix troubled core businesses, a trend that in previous booms has ended poorly for investors.

The desire of companies to band together and reduce overlapping costs won’t diminish any time soon, particularly as the prospects for global economic growth look mediocre at best. Thanks to Pfizer’s combination with Allergan, the value of worldwide announced M&A reached $4.2 trillion this year, according to data compiled by Thomson Reuters, up from around $3.5 trillion last year, and surpassing the record achieved eight years earlier.

Pfizer isn’t the first healthcare company to take advantage of a so-called inversion, wherein it merges with a rival based outside the United States to reduce the overall tax burden in ways that enhance the bottom line. Pfizer’s is, however, far and away the biggest on record: The drugmaker led by Ian Read is expected to save $1.7 billion in payments to the tax man by 2018, according to an analysis of the deal by my colleague Rob Cyran.

What’s more, Pfizer’s inversion is larger than the previous 10 such deals in the industry combined. That includes the $66 billion merger with Actavis that created Allergan earlier this year. Together, those transactions add up to around $140 billion in value, Thomson Reuters data show.

At least Pfizer can justify the expenditure on Allergan using arithmetic, however illusory the savings may turn out to be if the U.S. government modifies its tax code in the next couple of years. A handful of smaller takeovers, unveiled in the days leading to Pfizer’s big one, are harder to fathom, and point to an anecdotal spate of distracted dealmaking that is often emblematic of a peak in the M&A business.

Take the case of Urban Outfitters, the $2.9 billion apparel retailer, buying a pizza chain. Its acquisition of The Vetri Family group of restaurants is guided by the notion that Urban Outfitters, which also operates the Anthropologie brand, can increase foot traffic to its stores by selling customers food and beverages alongside scarves and underpants. According to Urban Outfitters Chief Executive Richard Hayne: “Spending on casual dining is expanding rapidly, and thus, we believe there is tremendous opportunity to expand the Pizzeria Vetri concept.”

While consumers may be spending more on mozzarella than denim, it’s a clear instance of strategic shift for a fashion company in trouble. Urban Outfitters shares have lost more than a third of their value this year. Its third-quarter sales, released shortly after the pizza purchase, came in shy of what analysts had been expecting and its same-store sales barely budged from the year before.

Pandora, the $3 billion music-streaming pioneer, is another example of a company reverting to M&A to stray beyond its challenged main operations. Like Urban Outfitters, the market has not been kind to Pandora shareholders, who are down some 20 percent on their investment year to date. It’s not usually a show of confidence, however, that the company has been buying assets in so-called “adjacent” businesses to its own.

On the same day Urban Outfitters got into the pizza game, Pandora agreed to pay $75 million for some technology and intellectual property assets of Rdio, a rival service of sorts that filed for bankruptcy. The deal, coming after a profit-warning shocker and an earlier move into the “adjacency” of live music ticket sales with the $450 million purchase of Ticketfly, further unnerved shareholders.

Pandora’s boss Brian McAndrews described the deals as “defining the next chapter of Pandora’s growth story.” The implication, however, is that Pandora’s current chapter is over. ConAgra, meanwhile, has already started and ended a new phase within this very deal cycle. It disastrously tried to marry its branded consumer goods like Chef Boyardee with the white-label Ralcorp. Some two years after paying $5.1 billion for the business, it agreed last month to offload it to TreeHouse Foods for $2.7 billion.

Earlier eras experienced similar adjacency calamities. Nokia got into mapping software with Navteq, paying $8.1 billion in 2007 and offloading it this year for $5 billion less. In a previous boom, Germany’s Daimler spectacularly failed to combine its luxury car know-how with the mass-market Chrysler. And the AOL-Time Warner combo of that vintage still stands as the mother of all mission drifts.

As such deals increasingly characterize the latest M&A bacchanal – along with those where clever financial structures overwhelm strategic logic – it presents strong evidence of a last hurrah.

This view is a Breakingviews prediction for 2016. Click here to see more predictions.


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