Yesterday’s stunning announcement by the US Treasury, which released a report titled “Treasury Announces Additional Action to Curb Inversions, Address Earnings Stripping“, and which was clearly aimed at ending not only all tax inversions, but the biggest pharma M&A deal in history, Pfizer’s tax-inverting takeover of Allergan (pardon Actavis) hit AGN like a ton of bricks, sending the stock crashing 20%.
As we previewed last night, we expect numerous M&A arbs to be puking up blood this morning, following the biggest spread blow out in recent history in a $100+ billion deal that involved virtually everyone, from plain vanilla funds to the fastest of the fast money.
But is the deal over? Here are some Wall Street opinions (via BBG).
Citi: “Deal likely to be over”
- U.S. ownership of combined Pfizer-Allergan will probably approach and may exceed 80% threshold under new Treasury Dept. regulation, “likely precluding” deal from taking place as an inversion, Citi analyst Liav Abraham says in note.
- Even if domestic ownership is in 60%-80% range, Citi says PFE would probably have difficulty importing its offshore cash balances, providing sufficient cause for the deal not to move forward
- Expects AGN will see multiple contraction over near term as deal had insulated stock from recent multiple contraction in specialty pharma; says AGN warrants premium to peer group due to earnings quality, growth profile and balance sheet,
Evercore ISI: “Pfizer-Allergan deal trading like it’s “95% dead”
- Arbs focused on 3-year look back provision for AGN acquisitions, whether co. will be viewed as appropriately sized for a deal, Evercore ISI analyst Mark Schoenebaum says in note
- Arbs note that the Treasury Dept. regulations released Monday are “proposals” and aren’t “implemented;” unclear whether cos. would litigate damages
- Deal includes clause that may require only $400m breakup fee on “adverse changes in tax law,” Evercore ISI analyst Umer Raffat writes
Bernstein: “distinct possibility” regs don’t end up jeopardizing the PFE-AGN deal
- Bernstein analyst Tim Anderson says in note that there’s a “distinct possibility” that the new Treasury regs don’t end up jeopardizing the PFE-AGN deal
- If AGN pact falls through, PFE could revisit AstraZeneca or Glaxo if rules don’t squash appetite for inversion deals
Jefferies: “Treasury may derail the PFE-AGN deal“
- Jefferies analysts led by Jeffrey Holford say in note that Treasury action may derail the PFE-AGN deal and could spell the end of PFE’s inversion attempts
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But the best summary of what just happened comes from Goldman’s Alec Phillip, as explained in his overnight note “Treasury Releases New Inversion-Focused Tax Regulations.” The implications are substantial not only for Allergan, but the entire inversion space.
From Goldman:
BOTTOM LINE: The Treasury has released regulations that might increase the effective tax rate of foreign companies operating in the US and would put further restrictions on some pending and future corporate inversion transactions.
MAIN POINTS:
1. The Treasury released stronger-than-expected changes to tax rules related to inversion transactions. This marks the third set of inversion-focused rules changes since 2014. While the first set of changes in September 2014 was stronger than expected, the second set in October 2015 was much more incremental, creating an impression that the Treasury might not make any further significant changes. By contrast, the changes the Treasury proposed today (April 4) go beyond inversion transactions per se and focus on a practice that foreign firms—not just inverted companies—use to lower their US tax rate, as well as transactions that do not technically meet the definition of inversions but which the Treasury believes to be inversions in practice.
2. “Earnings stripping” changes are broader than expected but it is not yet clear how significant an effect on effective tax rates they will have. Under current law, foreign companies can lend to their US subsidiaries, which then pay tax-deductible interest in return. This has the effect of reducing taxable earnings in the US and increasing it in lower-tax jurisdictions. The Treasury raised the possibility of changing the rules in this area in its 2014 anti-inversion notice, but after more than a year of inaction many observers had concluded that the Treasury might not act. Ultimately, the Treasury has applied this change to all foreign-owned companies, but has not specified quantitative thresholds or ratios above which interest deductions would be disallowed (some tax experts have proposed tightening existing debt-to-equity and/or interest-to-income ratios). Instead, the Treasury is requiring greater documentation of, among other things, a reasonable expectation of repayment and a legal obligation to do so. It is not clear what effect this will ultimately have on foreign firms’ effective US tax rates, but it could result in incrementally higher tax liabilities (this does not generally affect US-based firms, because interest income earned abroad is usually taxed by the US as it is earned).
3. “Anti-stuffing” rules could change the tax treatment of pending cross-border transactions. Under the new rules, cross-border M&A transactions that involve a series of acquisitions would become more likely to be counted as inversions for tax purposes, even if under current rules they involve a large enough ownership change (greater than 40%) to avoid more restrictive treatment. Specifically, the Treasury states that it is focused on transactions, for example, where a foreign company acquires a US company, and the combined firm then acquires another US firm in a subsequent transaction. Treasury also states that how these transaction are treated “should not depend on whether there was a demonstrable plan” to undertake a series of transactions, i.e., the Treasury would consider unrelated transactions to nevertheless be related and thus subject to more restrictive treatment if the transactions occurred within three years of one another. The upshot is that pending and future transactions that would have previously avoided the more restrictive tax treatment applied to inverted companies could now be subject to them. For transactions that involve between a 20% and 40% ownership change, this can mean additional tax on inversion-related gains and greater tax consequences for accessing unrepatriated foreign earnings for ten years following the transaction; for companies with less than a 20% ownership change, this would mean continued treatment as a US-domiciled company despite the transaction. The rules will apply to transactions that close between April 4, 2016 and April 4, 2019.
4. These changes will be made unilaterally and no congressional approval is required. The Treasury is making these changes via regulation on the basis of existing laws, so the announced policies are essentially final unless the Treasury decides to revise its interpretation of the laws again in the future. That said, it is possible that some companies involved in transactions that would be restricted under the new rules could bring a legal challenge against the changes.
via Zero Hedge http://ift.tt/228Sn7K Tyler Durden