- Pfizer and Allergan both fell on news of the Pfizer-Allergan deal for $160 billion.
- Allergan thinks it can cut costs and move Pfizer's cash into shareholder pockets.
- Washington may have something to say about all that.
The AOL (NYSE:AOL)-Time Warner (NYSE:TWX) deal in early 2000 represented the end of the dot-com bubble. AOL shareholders actually got a majority of Time Warner, but the price represented the peak of what Internet stocks might be worth, and once that peak was seen the air went right out of the balloon.
The Monday agreement by Pfizer (NYSE:PFE) to “buy” Allergan (NYSE:AGN) for $160 billion, including 11.3 shares in the new company stock, plus cash, may represent a similar peak in the health care sector. The word "buy" is in quote marks because technically Allergan, which is based in Ireland, is buying Pfizer, although its shareholders will own only 44% of the combined company.
Drug stocks have been on fire this year, driven by a desire to move from the US, with its 35% corporate tax rate, to jurisdictions like Ireland, which taxes profits at 12.5%. Allergan took advantage of this to acquire several large companies over the last three years, in the process changing its name from Actavis,
The artist behind all this is Brent Saunders, who first sold Bausch + Lomb to Valeant Pharmaceuticals (NYSE:VRX), then began putting together Allergan after investor Carl Icahn urged Forest Labs to hire him in 2013. He sold Forest to Actavis and took over there, then sold Actavis to Allergan and took over there. Now he’s selling Allergan to Pfizer and is presumably going to take over there.
The key to what Saunders calls "growth pharma" is to cut expenses, raise prices, combine many drugs under one sales force, and move the profits around the world for the tax advantages it presents.
Pfizer-Allergan will, assuming the deal closes in the second half of next year as anticipated, be the largest drug company by revenues. There are few other deals anywhere of this magnitude available in the space, and in moving the huge US drug complex overseas, Allergan and its peers risk killing the goose that lays its golden eggs.
That goose is the enormous subsidy paid by US patients to access these drugs. Medicare is prohibited by law from bargaining on drug prices. Once any drug is approved for sale it can be freely marketed, and price is never an object. It’s getting the doctor’s name on the prescription that counts, and companies like Valeant have spent big money running “specialty pharmacies” that are designed to make sure that those brand name scrips are executed.
The industry’s lobbying group, called PhRMA, has close ties to both Democratic and Republican politicians, but its strength in Washington is put at risk when it becomes a lobbyist for foreign interests. As the US political season heats up, deals like Pfizer-Allergan, and Valeant’s scandals, the sector is a prime political target for those who wish to cut the costs of care.
Growth pharma, in short, is based on short-term thinking, squeezing costs and grabbing tax advantages. That may be why, while the Pfizer deal was worth $360-380 per share when it was announced, shares in both companies fell on the news, making the actual value of stock in the transaction just $351/share.
In the near term, Allergan will get access to Pfizer’s international cash, and it will be able to drastically cut Pfizer’s research and sales costs. But with a current Price/Earnings multiple of 28, Allergan looks fully valued, and the cost cutting could well be outstripped by price cutting, especially if Democrats manage to hold the White House.
You can probably buy Allergan here and get a profit of 12% or so over the next nine months, as the price of the stock approaches the price being offered by Pfizer. After that, however, you might be advised to take the money and run. It’s going to be a bumpy ride from there.