The recent furore over the prospective takeover of AstraZeneca by US pharmaceutical conglomerate, Pfizer, for approximately $100 billion was to be expected.
Having initially, and rightly, proclaimed the proposed takeover as a vote of confidence in the UK as a destination for investment, the government have tepidly scuttled back to the territory of ‘seeking assurances’. Business Secretary Vince Cable has now proclaimed that he is prepared to intervene in the takeover if he needs to, and even proposed reviewing the UK’s takeover code to allow the UK government to block such takeovers.
There are, however, a few things worth examining and understanding about this deal to see just why the UK should be heralding it as a big success and should desist from meddling in the proposed merger.
The reason for the takeover
First things first – this is not about AstraZeneca’s pipeline of new drugs.
Sure, some of their immunotherapy treatments have promise but it’s not game changing stuff. A lot of their patents are expiring and under threat by generic competition. Although it’s currently reorganising, it’s just turning round from having one of the weakest research & development groups in the sector.
It certainly isn’t because the takeover represents great value either.
Using a number of commonly used investor ratios, it’s not hard to understand why AstraZeneca has been out of favour with many investors for a few years. The company has been generating lower earnings per share for the last three years and net profit margins have fallen spectacularly. In 2011, AstraZeneca’s net profit margin was a tidy 29.5 percent. Fast forward to 2013’s full results, and it was down to 9.9 percent.
Furthermore, at the current share price (near Pfizer’s offer price), the Price/Earnings multiple is very stretched at 35.2 times last year’s earnings, compared with 17.3 times for Pfizer or 14.3 times for its rival GlaxoSmithKline. Even once we factor in the possible tax savings, this would still result in the merged companies Price/Earnings ratio becoming stretched to something around 22 times last years combined earnings for the two companies, assuming there isn’t a sell off after the takeover (which such a high price/earnings multiple may well lead to).
It is, however, very much to do with Pfizer being able to drive down their tax bill.
Given that a company needs 20 percent British ownership of its combined groups shares to deem itself to be based in the UK, the AstraZeneca merger would enable it to rebase itself as a UK company (albeit still headquartered in the US) after a merger that would leave British ownership of the combined company at around 27 percent. There are a few key reasons that this would produce a significant saving- potentially significant enough to warrant paying $100 billion.
- The UK has a much lower rate of corporate income tax (21 percent versus 39.1 percent in the US), which would allow Pfizer to make a significant saving on its tax bill if it were to legally rebase itself in the UK for tax purposes.
- The UK has a ‘patent incentive’ whereby profits from UK patents are only taxed at a rate of 10 percent. For drugs companies
- UK based companies aren’t required to pay tax on profits made overseas, while they are required to do so in the US. The offshore cash pile for Pfizer is a significant sum, standing in the region of $73 billion. Were it to repatriate this to the US at present, it would be on the hook to pay tax on this. The cost to Pfizer of doing so would be around $28 billion.
These combined factors would allow Pfizer to cut its effective tax rate from 27.4 percent paid last year to 20 percent. With every percentage point less of tax worth approximately $200m in lower expenditure in tax payments for Pfizer, the total saving could be $1.4 billion annually.
What’s the reason for objecting?
There are three camps of objectors – the AstraZeneca board, the UK opposition (Labour), and the US government. It shouldn’t be too hard to understand the motive of each of these.
The AstraZeneca board are concerned with two things. First and foremost, they don’t want their company to go on the cheap. They’ll put up stiff resistance in order to ramp up the price Pfizer pays for the company. What’s more, given the board room of any merged company would be slimmed, they’re also fighting for their own jobs or at least a half decent pays off following the merger.
Then we have the political motives. The UK opposition comes chiefly from the Labour Party – a party that has made pledges to encroach on the activities of private enterprise in a bid to show they are on the side of the ‘little guy’. Having watched their poll lead slowly erode, it is understandable that Ed Miliband will be looking to curry favour with the electorate by ‘standing up for British jobs’ by advocating protectionism.
His motives shouldn’t be confused with genuine altruism, however. His rejection of a meeting with the CEO of Pfizer citing the fact he was too busy campaigning for the local elections is demonstrative how shallow his concern really lies for the implications of any such takeover.
An ulterior motive? Labour’s poll lead over the governing Conservative Party has been sliding for the last year (Source: UK polling report)
Meanwhile, the concern of the US government isn’t rocket science either. They know their tax code has become highly uncompetitive by international standards and are jumpy about US companies seeking ways of circumventing their lucrative tax payments to the US Treasury.
A sensible solution would be to consider reforming the tax code to one that is more business friendly, although there is seldom much appetite for wholesale reform of the tax code and reducing what is the highest rate of corporation tax in the developed world.
Why this is good news for the UK government
Contrary to the concerns expressed, this is a vote of confidence for the UK as a competitive place to do business. Having lowered the rate of corporation tax from 30 percent to 21 percent, the Coalition government has got the attention of big multinationals who may seek to invest in the UK and grow their operations in an area where taxes are less of a burden.
That said, it isn’t likely to produce a significant boost for tax revenues as UK tax law generally only requires UK tax to be paid on profits relating to business activity conducted in the UK.
One area of concern is jobs and continued investment in Research & development in the UK. Although Pfizer has committed to maintain 20 percent of the combined groups global R&D workforce in the UK, it’s a little hazy what this means for thousands of other jobs. The combined R&D force of the two companies is 19,880 (10,880 at Pfizer and 9,000 at AstraZeneca) which means the commitment covers around 4,000 jobs. Currently, the separate companies employ around 9,200 UK based employees.
That said, AstraZeneca has already been slashing its headcount and there’s nothing to say it wouldn’t have to continue doing so as a standalone company unless it is able to improve its pipeline. When the company cut 7,300 jobs back in 2012, around 300 of these were at its R&D team at Cheshire as part of 700 job cuts in the UK.
Of course there may be some ‘synergies’ (or cost cutting) where there is the possibility to combine operations- there’s little point in a merger if this isn’t possible- but efficiencies are part and parcel of almost every merger. It’s right that the UK government shouldn’t make it its business to interfere with companies streamlining themselves to be as efficient and competitive as possible.
What’s more, provided the UK tax regime remains favourable and we have a skilled workforce able to develop an innovative pipeline of drugs, it’s not clear what motivation there would be for taking a hatchet to a profitable operation.
Also, the windfall for UK holders of shares in AstraZeneca would be significant. With the possibility of a £52 a share takeover, the final price could represent a 40 percent gain on where the shares were trading before the bid talk began (at around £37).
Putting an end to the bid would potentially scupper the chance to realise anything between £15-£25 billion (or $25-42 billion) worth of gains for shareholders in AstraZeneca- many of whom are UK based or whose pension is invested in the company.
That’s not exactly small change we’re arguing about here, and illustrates what is at risk by not letting the takeover go through.