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The end of transatlantic M&A in pharma? The clampdown on tax inversion and implications for pharma
As we discussed in a blog earlier this year, it was clear early on this year that 2014 will be remembered as the year in which M&A activity returned in a big way to the global pharmaceutical industry. The merger announcements between AbbVie and Shire, Mylan and Abbott (over the latter's generics division), Medtronic and Covidien, Walgreens and Alliance Boots, and Salix and Cosmo all showed that pharma companies were bullishly moving into M&A again - even if the largest of the potential deals, between Pfizer and AstraZeneca, eventually did not materialise.
One of the major hallmarks of this M&A activity was the spectre of tax inversion - was it a coincidence that all of these acquisitions would result in a US-based company moving its domicile to a European country with a lower tax base (Ireland, Jersey or the Netherlands)?
Tax inversion has always been an option for any US-based company - essentially, it provides a series of tools to diversify a company's tax base and use the earnings from its foreign subsidiaries without tying it to US corporate taxes. However, most companies have not sought to take advantage of these tools for fear of falling foul of the US Treasury and a resulting public and political backlash. Ultimately, however, once some companies started to test the waters and chip away at the dam, the dam burst - resulting in a flurry of activity where tax inversion was explicitly or implicitly one facet of the proposed acquisition.
The pharmaceutical industry is particularly prone to the idea of tax inversion and the vast bulk of the M&A activity this summer that was linked to tax inversion was in the pharmaceutical or healthcare space. This is because pharmaceutical companies tend to have a major global asset base split across the US and Europe, as well as the fact that pharmaceuticals is a high margin business with a comparatively high corporate tax rate.
As I mentioned this morning in an interview on CNBC's Squawkbox, the pharmaceutical industry is also undergoing unprecedented turmoil from government price cuts; inorganic strategies are an increasingly attractive way to increase top-line growth.
A backlash was inevitable. By the time the Treasury announced a series of fairly dramatic measures to combat tax inversion at the end of September, the markets had generally already priced in the risks of increased red tape around this area - and a series of European companies that were seen as prime targets for an acquisition lost significant market value as a result.
The Treasury has already indicated that this is not the end, and that more regulation is likely. It is also currently entirely unclear whether the Treasury had the authority to engage in such severe reform of the tax inversion system without proper legislation, and indeed also make it retroactively applicable to any acquisition that had not yet closed. But its impact has been immediately clear - Salix's acquisition of Cosmo is off and virtually every company involved in an acquisition has had to position itself against the new rules, even if only to confirm that they will push ahead with the merger. For most of the acquisitions, it appears that at the very least the new rules will devalue the deal significantly - but not enough to call the merger off, even if it means that the financing of the deal will have to be amended (indeed AbbVie's acquisition of Shire even includes a clause the deal cannot be called off due to any change in regulatory climate on this issue).
Hence it appears that whilst the Treasury's new rules have had a desired impact, there will need to be more forceful reforms to render tax inversions completely unappetising for pharma companies. And whilst Congress will likely focus on broader tax reform in 2015, it has a fight on its hands - companies will likely fight against portions of the new tax inversion clampdown, and particular its retroactive application. And the reform of the broader corporate tax standards in the US is fraught with complications - whilst the US does have a high nominal corporate tax rate, there are a number of tax credits and benefits which somewhat counterintuitively may prevent the overall corporate tax rate from being lowered.
In the meantime, global pharma companies have a number of other tools at their disposal to diversify their tax base. And the clampdown on tax inversion may conversely render any renewed interest in a Pfizer-AstraZeneca deal more attractive - after all, AstraZeneca's main opposition to the deal was that it was felt to be an opportunistic tax exercise rather than a strategic acquisition. If the tax inversion angle is off the table, or a less attractive part of the deal, it will place the undeniable strategic benefits of a merger between the two more clearly into focus. The pharma industry has been no stranger to trans-Atlantic mergers in the past - dating back to the mergers of Hoechst-MMD, Pharmacia-Upjohn, SmithKlineBeckman-Beecham and Roche-Genentech - and there will always be a strategic rationale for such activity.
However, having already been burned once, the only question is whether Pfizer will want to go down this route again.
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