New US Treasury rules likely to cut deal prices – industry sources

Provided exclusively by Mergermarket

The US Treasury’s proposed rules against tax inversions will inevitably put a damper on outbound US M&A, irrespective of whether the proposals kill the USD 160bn Pfizer (NYSE:PFE) Allergan (NYSE:AGN) merger, industry sources said.

The move will likely deflate cross-border deal prices by stripping out any inversion tax benefits, they said.

Treasury’s proposed rules, announced 4 April, are aimed at discouraging US companies from redomiciling overseas to cut their tax burden. The measures would change the allowable size metrics for new and announced deals to qualify as inversions and thwart “earnings stripping,” or moves to shift multinational’s profit to lower tax jurisdictions and saddle US divisions with interest-deductable debt.

“You will still have M&A, but until yesterday, the juice was the tax savings,” said attorney William Dantzler, head of tax practice at White & Case. “That boosted the price for what buyers were willing to pay.”

A second industry lawyer said the rules, if they are enacted and withstand legal challenges, “will narrow the universe of companies that can invert, although it doesn’t eliminate the universe.”

International deals will still get done, but they will have to be posited more on industrial logic rather than tax benefits, the lawyer said. “Deals will still get done, but you may have to lower the price and it may be harder to agree on a price,” the lawyer said.

While the proposals do not mention Pfizer’s deal to acquire Allergan and redomicile to low-tax Ireland, they appear to be targeting that deal, bankers and lawyers said.

The rules labeled Allergan as a “serial acquirer” of US companies in which it issued stock for acquisitions. The new rules would reach back three years and redefine the company as its previous size to qualify for an inversion.

In the past three years, two US companies, Actavis and Forest Laboratories, redomiciled to Ireland through merger deals into what is now Allergan.

“Allergan becomes a much smaller inversion candidate,” said the industry banker. “It looks pretty powerful and Pfizer was certainly taken aback by it.”

The new rules are likely to withstand any legal challenge by Pfizer, since any litigation could last well into a new presidential administration and both leading candidates seem unlikely to reverse Treasury support for new rules, one industry banker said.

In response to Monday’s announcement, Allergan shares closed down 15% Tuesday, causing the net spread on the deal, which had widened to the 25% mark in recent weeks, to shoot up to 51%, according to Dealreporter analytics.

As recently as last week, Citibank analyst Liav Abraham had noted the widening spreads of the deal but said “our legal due diligence points to limited actions that could be administratively undertaken without the passing of legislation,” adding the bank expects the deal to close this year.

There is now widening speculation that Pfizer’s options are limited to renegotiating the deal or abandoning it, with the latter seemed more likely, the two bankers noted. One of the bankers said Pfizer CEO Ian Read, who staked his reputation on the deal closing, could be forced into retirement.

“I think Pfizer has little choice but to walk away,” the second banker said. “It could cost Read his job.”

News outlets including CNBC and Reuters quoted sources saying Pfizer could walk away from the deal.

Alex Mostovoi, tax director for Focus Financial Partners, said Treasury’s new rules could “kill the deal because of the retroactivity feature,” since they go back three years and make “Allergan significantly smaller than Pfizer had assumed.”

“My bet is that this time the deal may be off,” said Mostovoi.

A Pfizer spokesman said the company is reviewing the Treasury announcement and would not speculate on its impact. A source familiar with the deal said only some of the Treasury moves were expected. However, the depth, length and extent of the proposals required more analysis.

Aside from Pfizer-Allergan, other inversion deals announced this year include Johnson Controls‘s (NYSE:JCI) USd 16.5bn deal to buy Ireland-based Tyco International (NYSE:TYC) and IHS‘s (NYSE:HIS) USD 13bn deal to buy UK based Markit (NASDAQ:MRKT). IHS and Markit told the Financial Times today that it did not expect the merger to be affected by the new Treasury proposals.

by Dane Hamilton and Bhavna Kaul in New York, Alex Tarrant and Mintoi Chessa-Florea in London and Ryan Lynch in Washington DC

As seen in the mergermarket newsletter on 05/04/2016


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