Pfizer/Allergan: Breaking Up Is Hard To Do (Unless There’s A New Tax Law)

The breakup fee for the Pfizer/Allergan merger would be $3.5bn in certain instances, but much lower, just $400m in expense reimbursement, if a party decides to terminate the deal due to an adverse change in law.

Both Pfizer Inc. and Allergan PLC would be on the hook to pay a hefty $3.5bn termination fee should either party back out of the deal because of a better offer, but the terms of the breakup appear to include a less financially painful exit should the US government change the tax laws in a way that would negate the economic advantages of the deal.

The terms of the merger agreement, laid out in an 8-K filing with the Securities & Exchange Commission Nov. 23, state that either company could terminate the agreement due to an adverse change in law by reimbursing the other party's expenses up to $400m. [See Deal]

The hedge appears to suggest some uncertainty on the part of Pfizer about how the US government may respond to its plans to complete a corporate inversion, redomiciling in Allegan’s Dublin, Ireland, to escape paying US taxes. The opportunity to lower its tax rate was the big motivator behind Pfizer’s $160bn merger with Allergan announced Nov. 23 (Also see "Pfizer’s Allergan Acquisition Paves The Way For A Split – But Delayed" - Pink Sheet, 30 Nov, 2015.).

Following the announcement, many politicians and legislators have called the plan an elaborate attempt to dodge taxes. Pfizer’s management, meanwhile, has countered that a lower tax rate is the only way it can stay competitive with international rivals and offer the best value for shareholders.

The US Treasury issued new tax guidance Nov. 19 in an eleventh-hour attempt to reduce the economic benefits of inverting, but with its limited authority, the changes were not significant enough to deter Pfizer (Also see "Pfizer’s Face-Off With The US Treasury Edges Closer" - Pink Sheet, 19 Nov, 2015.).

It’s not clear if the US government will make any attempts to block the merger now, but Pfizer is apparently only willing to bet $400m that it won’t, not $3.5bn. The adverse change in law the SEC filing refers to is one, “that in the opinion of tax counsel, would cause the combined company to be treated as a US domestic corporation for US federal income tax purposes.”

Both Pfizer or Allegan would have to pay the full amount, however, if one party’s board of directors makes a new recommendation in response to a “superior proposal” and the other does not. They would be required to pay $3bn if either party’s board changes its recommendation for a reason other than a “superior proposal.”

On the other hand, if one party’s shareholders vote down the transaction and the other’s shareholders approve it and neither board changes its recommendation, the termination fee would be $1.5bn.