Bonds backing Allergan (NYSE: AGN) gapped wider today after the U.S. Department of the Treasury and the Internal Revenue Service (IRS) yesterday announced a new round of tougher-than-expected measures to curb corporate tax inversions, in a new threat to the company’s planned all-equity merger with Pfizer (NYSE: PFE).
The proposed merger—valued at roughly $160 billion—was projected to significantly bolster Allergan’s credit profile, which had dropped from single-A to the cusp of investment grade status in recent years following a string of debt-financed M&A plays. All sides of Allergan’s BBB–/Baa3/BBB– ratings profile are at present under review for upgrades to reflect the potential “moderately leveraging” combination with the significantly larger and more diverse Pfizer, which is currently rated AA/A1/A+, and Allergan’s expectation of $40 billion in proceeds from the sale of its generic drug business.
When the much-anticipated merger with Pfizer was formally announced last November, AGN notes traded 15–20 bps tighter on the day and 30–35 bps tighter month to month, driving trades in the AGN 3.8% 10-year issue due March 15, 2025—which date to issuance on March 3, 2015 at T+175—to the low-to-mid T+140s.
But that 3.8% issue, which changed hands below T+130 as recently as mid-March this year, vaulted 30–35 bps wider this morning to trades in the low-to-mid T+170s, trade data show. Other AGN long-term bond issues also generally widened 30–40 bps this morning.
Under the now-imperiled merger plan, the combined entity would be renamed Pfizer plc and trade on the NYSE under the PFE ticker, though it would be combined under the existing Allergan entity and retain AGN’s current Irish legal domicile and principal executive offices, the companies said. Pfizer plc would have its global operational headquarters in New York.
To limit inversions, the U.S. Treasury yesterday stated that it would disregard foreign parent stock attributable to recent inversions or acquisitions of U.S. companies. “This will prevent a foreign company (including a recent inverter) that acquires multiple American companies in stock-based transactions from using the resulting increase in size to avoid the current inversion thresholds for a subsequent U.S. acquisition,” Treasury stated, adding that it would continue to explore new ways to combat the practice.
Allergan’s deal with Pfizer was the latest in a rapid series of big M&A developments. The 3.8% notes due 2025 came as part of a $21 billion, 10-part deal via Actavis—the third-largest corporate offering on record—backing its $66 billion acquisition of Allergan, before a name change to the latter in June last year, and after Actavis in July 2014 acquired Forest Laboratories for roughly $25 billion. But it was its $8.7 billion acquisition of Dublin-based Warner Chilcott in October 2013 that set in motion the events leading up to New York-based Pfizer’s inversion bid last year.
The Treasury said yesterday that it would also attack the befits of post-inversion “earnings stripping” by targeting transactions that generate large interest deductions to avoid U.S. taxation, while also allowing the IRS to divide debt instruments into part debt and part equity for tax treatment, as opposed to the current system that treats them as “wholly one or the other.”
Allergan and Pfizer said, in a joint statement yesterday, that they are conducting a review of the Treasury’s actions. “Prior to completing the review, we won’t speculate on any potential impact,” the companies stated.
Moody’s last November affirmed the A1 rating on PFE, with a stable outlook, noting that the deal would reduce exposure to “patent cliffs” while also bolstering cash prospects on inversion tax benefits.
S&P’s current downgrade review on PFE’s AA rating takes into account Pfizer’s share-repurchase ambitions, which include an accelerated $5 billion buyback announced on March 9 and a new $11 billion, open-ended authorization. S&P said it expected Pfizer to lean on its pro rata $70 billion of cash on hand to fund some of the “significant” repurchase activity in the years to follow a merger with Allergan, in a bid to combat post-merger dilution.
However, S&P estimated that the combined cash and cash flows of Pfizer and Allergan—coupled with assumed synergies—would likely facilitate at least $80–85 billion of buybacks over a three-year period without straining the double-A rating, “absent any major operational setbacks and debt-financed acquisitions.”
In light of the Treasury notice, S&P today stated today that it would likely remove Pfizer’s rating from CreditWatch and affirm the existing ratings should the transaction be terminated.
S&P also said its upgrade review on Allergan will continue, as it dates to Allergan’s announcement last July that it would sell its generic drug business to Teva Pharmaceutical Industries for $40 billion, with proceeds earmarked for deleveraging and acquisitions to bolster the remaining specialty pharmaceutical franchise. — John Atkins
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