Treasury suits up to fight Allergan merger

President Barack Obama

President Barack Obama has made no secret of his contempt for Pfizer's ($PFE) plans to merge with Allergan ($AGN) to move its headquarters to tax-friendly Ireland. Pfizer CEO Ian Read has made no secret of his determination to close that $160 billion deal, political backlash or no.

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Now, the two are butting heads over that deal. The U.S. Treasury Department rolled out new rules governing the sort of mergers designed to flip tax domiciles into other countries--and those rules appear designed to target Pfizer and Allergan.

The sticking point is this: Allergan and it Irish address are themselves a product of M&A, including at least two previous tax-advantaged deals. Under then-CEO Paul Bisaro, Watson Pharmaceuticals bought Swiss-based Actavis and took on its target's name. Then Actavis bought Ireland-based Warner Chilcott to move its domicile there, and after that, the now-Ireland-based Actavis bought Allergan, taking that California-based company overseas as well.

Meanwhile, one hurdle in current inversion rules sets a minimum percentage of shares in the merged company held by investors in the inversion target. Clear that minimum, and the surviving company escapes some onerous tax consequences.

The new rules would consider a series of cross-border deals to be related if they occurred within three years of one another, regardless of whether the individual deals cleared that minimum percentage. And for the purposes of calculating that minimum ownership, Treasury would disregard the value of any U.S. businesses snapped up by a foreign buyer over those previous three years.

Treasury Secretary Jacob Lew

"Some companies are serial inverters," Treasury Secretary Jacob Lew said Monday. "They acquire multiple U.S. firms in stock-based transactions over a short period of time. This increases their size and reduces the negative tax consequences of a subsequent inversion. Today's action takes away a significant amount of the tax benefits of these serial inversions."

That's not all the rules are set to do. They zero in on "earnings stripping," a practice that uses intracompany loans to offset earnings with interest charges. But the most spectacular--and immediate--goal of the new rules appears to be nixing the Pfizer-Allergan combo.

Pfizer says it's looking at the new rules and won't have any comment until after assessing them. And various analysts have different opinions about the fallout for Pfizer and Allergan: For example, Bernstein analyst Tim Anderson says it's a "distinct possibility" the deal will still go through, while Citi analysts say the deal is "likely to be over."

Even if Pfizer and Allergan can avoid the 80% threshold, Citi says, the deal could be scuttled. At a 60% to 80% U.S. ownership level, the company would have a hard time bringing home its overseas cash, and that could kill the deal, Citi says.

The two companies anticipated tax complications, and Evercore ISI analyst Mark Schoenebaum points out that a breakup fee could amount to just $400 million in case of "adverse changes in tax law." Meaning that Pfizer wouldn't lose a lot of cash, walking away--though it would lose the big fish it promised to land, and that, in turn, would put a lot of pressure on Read and his team to either find a follow-up deal or three, or step up their work toward a breakup.

Pfizer might not go quietly. Read and CFO Frank D'Amelio have repeatedly promised that their Allergan buyout will close, and they could throw a lot of lobbying and legal firepower at Lew's guidelines. Tuesday afternoon, Bloomberg cited sources saying that Pfizer's lawyers are analyzing the documents for a possible challenge in court. The deal also might be restructured or repriced or both, the sources told the news service.

Then again, Reuters reports that Pfizer isn't eager to get into a legal battle with the U.S. government, and its sources say the company is leaning toward walking away.

Of course, there's no decision yet. But one thing is for certain: The Pfizer-Allergan merger has been controversial from the start, and as the election season heated up, the deal has drawn more fire, and not only from Democrats. Republican presidential candidate Donald Trump lambasted Pfizer for the move as well. A "tax fairness" lobbying group calculated that losing Pfizer would cost the U.S. $35 billion in tax revenue, though some economists disagree with that figure.

In February, House lawmakers cited those numbers in urging President Obama to put a squeeze on inversion deals. So did Sen. Bernie Sanders last month in a letter demanding that Treasury take on the merger. At the time, Treasury said it would respond to Sanders' letter "in due course," and that time appears to have come.

It's also worth noting that government critics are far from the only ones questioning Pfizer's desire for a tax-saving merger. That Read has been "hell-bent on inverting" has troubled some investors because "it incurs the wrath of regulators and because it feels like pure financial engineering," Anderson pointed out in a Tuesday note. Pfizer might now decide that "inversion is dead," the analyst went on to note. Then again, even if this deal falls through, Read might get back on the inversion horse and ride after another target that clears the new rules.

- see the Treasury fact sheet
- read the comments from Secretary Jacob Lew
- and the Bloomberg report
- more from Reuters

Special Reports: The top 15 pharma companies by 2014 revenue - Pfizer | The most influential people in biopharma today - Ian Read - Pfizer

Editor's note: This story was updated with additional analyst comments and background on lobbying against the deal. A second update added new developments Tuesday afternoon.

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