Perrigo’s Irish Move Sets Stage For International Boost, Net Revenue Gain

OTC private label leader Perrigo acquires Irish firm Elan for $8.6 billion in a deal that will bring tax savings from being incorporated in Ireland, provide a stage for European expansion and tap into Elan’s royalty rights. “Simply stated, we're going to be able to further our international platform,” CEO Joseph Papa says.

Perrigo Co. PLC will set up a launching pad to boost its net revenues by re-incorporating in Ireland, through its acquisition of specialty pharma Elan Corp. PLC, and escaping higher U.S. tax rates.

Perrigo on July 29 announced it will buy Elan for $6.25 per share in cash plus $10.25 per share in stock, or approximately $8.6 billion as of the July 26 market close; this represents a premium of about 10.5% over the Irish firm’s closing price. Legacy Elan shareholders also will receive 0.07636 shares of the new Perrigo for each Elan share.

The deal provides a new corporate home in Ireland because Perrigo is merging with a firm in that country, not simply moving there. The purchase also brings access to royalties for the multiple sclerosis drug Tysabri, which Elan discovered before selling it to Biogen Inc. in February 2013.

Perrigo executives emphasized during a same-day call with analysts that the firm, currently based in Allegan, Mich., is acting on a plan to expand its international business by acquiring Elan and is not changing its business model to new drug development.

The firm will continue to focus on making private-label OTCs – a category it leads in the U.S. – infant formula and other nutritionals, and Rx generics. Further, Perrigo will maintain its manufacturing, research and development facilities in the U.S., primarily in Michigan, and in other countries.

“What we've always stated is the desire to get into a more international platform to go global. And we feel that as that part of our strategic imperative is very important, we felt that the Elan organization can provide tremendous merits for us as we go to a more globalized company,” President and CEO Joseph Papa said during the call.

Papa pointed out Perrigo’s current business is limited mainly to the U.S., U.K., Canada, Mexico and Israel. While the deal brings “operational and tax synergies” for Perrigo, “more importantly” the firm has an opportunity to “create a hub in Ireland for us as we look to expand into Europe,” he said.

“Very simply stated, we're going to be able to further our international platform,” Papa added.

As analysts continued asking whether Perrigo is changing its core business focus, the CEO said: “The message is that we are looking at continuing to expand internationally with our core business. That is absolutely very clear. … I don't want anyone to think that we're going to start spending billions of dollars in R&D for the next biologic right now.”

One product category in which Perrigo already expects to grow international sales is infant formula. The firm in 2012 achieved compliance with international quality standards and gained FDA clearance to manufacture formula products at its facility in Vermont, shut down in 2011 for the installation of a $29 million packaging line. Papa said in January that Perrigo plans to include stage 1 and stage 2 milk-based infant formulas that comply with Codex Alimentarius Commission standards among more than 60 launches slated for 2013 (Also see "Perrigo Sets Strategy For Global Infant Formula Growth" - Pink Sheet, 14 Jan, 2013.).

William Blair Equity Research analysts said while they are interested in additional details on Perrigo’s outlook in its next earnings call, tentatively scheduled for later in August, the Elan deal does nothing to dampen their regard for the firm, which has a market value of about $12 billion.

“We would not necessarily call for multiple expansion from here but see the potential for upward earnings revisions … to move the stock higher over time. Longer term, we continue to like the Perrigo story given the company’s leading position in store brand over-the-counter health care products, share opportunity in Rx-to-OTC switch, and earnings upside aided by acquisitions,” according to a July 30 William Blair research note.

Leerink Swann analysts Jason Gerberry and Christopher Kuehnle also note the deal’s potential “as an opportunity to enhance international expansion,” but also question Perrigo’s reach into specialty pharmaceuticals. “Why is a consumer health care revenue-based [company] targeting a specialty pharma with, in our view, questionable top-line growth prospects?” they said.

Good Position To Grow Any Business

No matter what part of Perrigo’s business drives its international sales, the firm will be positioned to keep more of its revenue as an Ireland-based entity.

Tax law expert Michael Knoll pointed out that like other firms that currently earn most of their income in the U.S. and less from international markets, most of Perrigo’s revenues are subject to U.S. taxes.

“Since they’re not earning a lot abroad, there’s not a lot of income that presumably escapes U.S. taxes currently. This is a move that looks to be aimed to reduce the taxes on the income they hope to be earning in coming years overseas,” said Knoll, co-director of the Center for Tax Law and Policy at the University of Pennsylvania, where he is a professor of law and of real estate.

Under its “worldwide tax regime,” the U.S. taxes persons and U.S-based corporations on their worldwide income, allowing tax credits for taxes paid on income earned in other countries, he said in an interview.

Most other developed countries have territorial tax systems and tax the income earned within a country. “They don’t tax their residents, their individuals or their corporations on their foreign income at all,” Knoll said.

Changing Address, But Not Moving

In the U.S., firms’ foreign revenues are taxed at rates that cover the difference between the rates in the U.S. and other countries. While most other developed countries have tax rates similar to those in the U.S., some countries that account for significant sales for pharma firms and other industries have lower tax rates, some markedly lower.

On firms’ revenues from countries with lower tax rates, “the U.S. tax spike could be very high. So, there’s one incentive to get out from under the United States’ worldwide taxation,” Knoll said.

“It’s worth pointing out that, in this context, it is not necessary that they do anything more than change where they are incorporated, basically where papers are filed. It’s not necessary to move the business to accomplish that goal. You don’t have to change where production occurs, you don’t have to change where management occurs – all you have to do basically is re-incorporate abroad.”

Knoll noted that Congress and European authorities for some time have been concerned about businesses leaving a country for a corporate home with better tax rates, or remaining incorporated in a high-tax-rate country but keeping revenues off shore to avoid triggering some tax levies.

Recent high-profile examples of authorities’ concern about businesses’ strategies for avoiding higher tax rates include U.S. lawmakers’ scrutiny of computer and mobile device firm Apple and U.K. officials’ criticism of coffee and food retailer Starbucks.

“The idea is to capture the gain that otherwise might escape taxation,” Knoll said.

He added that U.S. tax law puts some impediments in the way of firms changing their corporate home to another country, in what are called “inversion transactions,” but the incentives are too good to pass up for some businesses. The impediments include triggering a tax, on shareholders as well as corporate entities, at the time an inversion transaction closes, “rather than then treating them as tax-free transactions which they otherwise would be.”

Pharmaceutical firms could be among the most interested in inversion transactions, largely due to the firms’ intangible assets, such as trademarked brand names, drug formulation patents, molecules in their pipelines and proprietary technologies.

Pharma firms including Valeant Pharmaceuticals International Inc., Jazz Pharmaceuticals PLC and Alkermes PLC have made the move to lower their tax rates by acquiring a company in a more favorable tax environment and moving their bank accounts to that location. Most recently, Allergan PLC found a tax refuge in Ireland with its May acquisition of Warner Chilcott PLC (Also see "Actavis’ Warner Chilcott Buy Brings Switch Options In Diversified Portfolio" - Pink Sheet, 27 May, 2013.).

“What’s often very important is having intangibles, or what often makes it easier to do is if a lot of the value is tied up in intangibles. That is certainly the case for the pharmaceutical industry, especially for the major pharmas,” Knoll said.

Ownership Split: 71/29

Perrigo said the Elan transaction will be taxable for U.S. federal income tax purposes to shareholders for both firms. Perrigo shareholders are expected to own approximately 71% of the combined company while Elan's shareholders are expected to own approximately 29%.

The proposed takeover has been unanimously approved by the respective boards of directors and is expected to close by the end of 2013. The new company will be incorporated in Ireland with an expected name of Perrigo Company PLC, or something similar, and will be headed by Perrigo’s current leadership team.

The deal followed Dublin-based Elan’s rejection of three hostile bids by Royalty Pharma and a management-shareholder clash over strategy. Elan began looking for a buyer this year after Royalty Pharma’s initial offer (Also see "Elan Shareholder Vote Indicates Lack Of Faith In Management’s Decisions" - Pink Sheet, 17 Jun, 2013.).

Perrigo estimates establishing its legal domicile in Ireland and reducing operating costs will drive annual after-tax savings of $150 million, some from lower taxes and the remainder from eliminating duplicative expenses and capitalizing on other cost synergies.

The firm said it secured $4.35 billion in fully underwritten bridge financing commitments from Barclays and HSBC Bank USA, N.A., which, in addition to Perrigo’s cash on hand, are available to finance the cash portion of the transaction, pay fees and expenses related to the transaction and refinance Perrigo’s existing indebtedness including its current term loan, private placement notes and existing public bonds. Perrigo plans to refinance and repay the bridge borrowings through new debt issuances and the use of Elan cash on hand.

In February, Elan announced it had renegotiated its Tysabri ownership rights with Biogen. Under the new structure, Elan gave up its 50/50 profit split for the multiple sclerosis drug in exchange for a $3.25 billion upfront payment and a healthy double-digit royalty on sales. The Dublin-based company currently earns 12% of Tysabri sales but from May 1, 2014, the royalty increases to 18% on all sales under $2 billion and 25% on sales over $2 billion after that. Further upside exists if Tysabri is approved for secondary progressive MS (Also see "Elan Prepares For A Buying Spree Now That Biogen Has Taken Over Tysabri" - Pink Sheet, 6 Feb, 2013.).

Elan CEO Kelly Martin said that in addition to offering a fair value to the firm’ shareholders, the deal enhances Elan’s outlook for developing and launching new drugs. “Over the last six or seven years, [Perrigo has] executed almost flawlessly, built value,” Martin said during the call with analysts.

“And if you think long-term … extending their business model globally, we would think would add enormous opportunity for shareholder value down the road,” he said.

[Editor’s note: This story includes information from Elsevier Business Intelligence’s “The Pink Sheet” Daily, providing daily, in-depth analysis of the key developments shaping the biopharma industry.]