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Cosmetic surgery

29 October 2015 By John Foley

There’s no easy cure for tax. Pfizer, the U.S. pharmaceutical group, is eyeing a merger with rival Allergan, the Wall Street Journal reported on Oct. 28. No wonder: Pfizer is duty bound to pay 25 percent of its profit to the American government, while its Botox-making peer has a tax rate of just 5 percent. Yet persuading Allergan to share its expertise could be as painful as the saggy-face surgery its customers hope to avoid.

Pfizer’s attempt to merge with tax-lite rival AstraZeneca fizzled last May. Astra is now too small to tick one of the likely must-haves for a so-called inversion where one company body-snatches another’s tax rate – namely that the target emerges with 40 percent of the combined group. Given Pfizer chief Ian Read’s desire for a “competitive tax rate”, the most likely targets are GlaxoSmithKline and Allergan. The latter, domiciled in Ireland but heavily geared to the United States, may come with fewer political strings than its similar-sized UK-listed peer.

The question is at what price. Allergan would have only 34 percent of the $332 billion combined group if the companies were crunched together at their latest traded values. That means Pfizer would need to pay a premium out of whatever savings it hoped to make on its taxable profit.

Those are not small. Analysts estimate Pfizer’s pre-tax profit in 2017 will be $21 billion. Cut its tax rate from 25 percent to, say, 15 percent, and the annual saving would be $2.1 billion. Finally, pop that on the 10 times forward earnings at which Pfizer has, on average, traded over the last decade according to Eikon data, and it’s worth $21 billion. The snag is that Allergan is in a strong position to demand a big chunk of that value for itself. The companies’ combined values including tax savings are a notional $353 billion. Giving Allergan shareholders 40 percent of that to satisfy the tax inversion requirements would equate to a 25 percent uplift. And it leaves no uplift at all for Pfizer.

Pfizer can smudge the numbers a little. The real tax rate could turn out to be even lower. And Pfizer could create more value by cutting Allergan’s costs – though if that is the game, boss Brent Saunders may rather pursue acquisitions of his own. There is doubtless room for negotiation – but Allergan holds the upper hand.



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