Pfizer Takes Another Little Blue Takeover PillOn 4/28/14, Pfizer Inc. (NYSE-PFE) confirmed prior discussions with AstraZeneca PLC (XLON-AZN & NYSE–AZN) and a continuing interest in a possible combination via a merger transaction. Separately, AZN confirmed that the PFE Chairman contacted its Chairman (on 4/26/14) to have a discussion, their first communication since the initial approach in January 2014. PFE wanted to issue a joint statement on 4/28/14 publicly disclosing that the companies were involved in discussions. However, the AZN Board determined that it was not appropriate to engage in discussions absent a “specific and attractive” proposal. The companies previously met on 1/5/14; AZN disclosed PFE made a “preliminary and conditional” proposal consisting of 1.758 PFE shares and £13.98 cash per AZN share (£46.61 value based on a $30.52 PFE close price on 1/3/14). AZN concerns included the large proportion of stock consideration and the proposed tax inversion deal structure (from redomiciling the combined entity in the UK). In addition, AZN felt the proposal “very significantly undervalued” the company and its future prospects, specifically its diabetes franchise and oncology pipeline. The proposal was rejected by AZN on 1/12/14; a few days later, PFE notified the company that it was no longer actively pursuing a transaction.
While AZN has verbalized “no, no, no”, its body language is saying “yes, yes, yes” (to the right price premium and deal terms). PFE is now in a 30 calendar day period before it is required to give a firm intention; otherwise, any future proposal would be frozen in a six month penalty box (except if both the Takeover Panel and AZN agree to extend). The company is speaking with AZN shareholders in the interim; there is institutional ownership overlap to which the deal synergies and lower tax rate should appeal. PFE was reported this morning to be preparing a sweetened bid which may be announced next week; we believe a takeover value in the low-mid £50s should ultimately carry the day. The proposal is subject to three conditions – customary due diligence, the unanimous recommendation of the AZN Board and AZN directors giving irrevocable undertakings to accept any offer – all of which may be waived in whole or part. PFE has an option to adjust the proposal based on a higher-than-projected AZN dividend payment for 1H14 and any “whitewash transaction” prior to a signing a deal. Last, the apparent urgency of PFE may be the recently announced specialty pharmaceutical mergers and any potential expedited crackdown by the U.S. government and/or tax authorities on overseas domicile relocations that take advantage of lower tax rates in certain foreign jurisdictions.
Though short of aggressive expectations of a £60/share takeover value, we feel the potential high-£30s downside price on no deal is something the AZN Board will have to very seriously consider if PFE proposes a deal with a low-mid £50s value. A £46.61 AZN deal value (1/5/14 proposal) is a 23% premium to the unaffected £37.82 AZN close price on 4/17/14 and a 21% premium to the £46.61 AZN prior 20 day average closing price. The initial light price premium is likely the basis to begin discussions rather than an ultimatum; we note that PFE has not disclosed a synergy estimate. Using the initial proposal and assuming $3.75B-$4.5B synergies (~5%-6% of 2014E combined revenues), 4.5% deal debt interest rate (~$30B debt) and a 20% tax rate, we estimate New PFE 2014E P/F $2.42-$2.49 EPS (~8%-11% accretive to standalone PFE $2.24 EPS). Based on PFE’s pre-deal 14x P/E multiple, New PFE would trade in the $34-$35 range. The implied £50/share deal value (1.69 USD/GBP exchange) is a ~32% price premium to the unaffected price. The AZN valuation multiples at £50/share are 13.9x EV/EBITDA (£4.68B, 31% margin) and 20.5x P/E (£2.46 EPS). At $35/share, New PFE would trade at a 10.5x EV/EBITDA multiple ($35.9B EBITDA, 48% margin); PFE pre-deal traded at an 8.6x EBITDA valuation multiple.
AZN has indicated that a larger cash percentage will be required from any further PFE proposals. The 70/30 stock/cash consideration does not seem to be set in stone but rather appears to be a starting point for negotiations. A 50/50 stock/cash deal structure (£26/share cash and 1.4 PFE shares) at a $31.50 PFE price implies a ~£52 AZN value (37% premium to the unaffected price). We note AZN holders are required to receive a minimum of 20% New PFE S/O for the change of domicile, which equates to a minimum ratio of ~1.27 PFE shares (per AZN share). A $35/share New PFE post-deal trading price under this cash/stock scenario implies a ~£55/share value (45% price premium). Assuming $50B deal debt (5.5% interest rate), a $6.5B drawdown of the combined cash and short term investments, and $3.75B-$4.5B of synergies, we estimate New PFE would have 2014E P/F $2.41-$2.49 EPS (8%-11% accretion). The combined entity would have ~3.0x debt/EBITDA leverage (including synergies) and 2.1x leverage including P/F $31B cash and short term investments; PFE should be able to retain an investment grade rating under this scenario.
AZN has weak near-to-mid term growth prospects; negotiating its share of the merger benefits may be more productive than having its Chairman defend the current business strategy and warn of potential social and corporate culture issues. Assuming a $50B valuation for deal synergies ($32M) and lower taxes ($18M), a 50% allocation would be worth ~£12/share. The implied £50/share deal price should be a good starting point for serious negotiations. Given the positive investor reception, the strategic product overlap and the continued consolidation of specialty pharma companies, we expect PFE to make a firm proposal for AZN. In addition, we view AZN’s response as a strong hint to bump the proposed price in order to commence negotiations. While accusations may fly about the poor track record of realizing consolidation benefits the pharmaceutical industry, we expect AZN shareholders will eventually succeed in getting their Board to succumb to a princely deal sum.
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