New Buy Allergen, PLC (AGN)

Pfizer (PFE) and Allergen, PLC (AGN) agreed to merge in a $160 Billion deal announced November 23, 2015 [Source].  It is a tax inversion transaction expected to close in the second half of 2016. Allergan trades at a considerable discount to the offering price offering a potential bargain.

Allergan (AGN) and Pfizer (PFE) Investment Thesis:
When a company announces it will buy another, the stock price of the acquirer (PFE) typically falls and the stock price of the target (AGN) rises but often not to the offer price. The discount reflects uncertainty that the deal might not go through. In this case it is a friendly takeover approved by both companies so the biggest risk appears to be regulatory.

Regulatory risk include attempts to block the transaction with anti-inversion regulation and the requirement to clear anti-trust regulations. No significant issues are identified by the companies including the U.S. Department of Treasury on anti-inversion. Ant-trust is not believed to be an issue as the two companies do not compete directly. Still Allergan trades at a considerable discount.

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The Transaction:
The combined new company will be named Pfizer PLC and trade under the PFE symbol. On completion of the merger Pfizer shareholders will own approximately 56% of the combined company and Allergan shareholders approximately 44%. The combined Pfizer PLC will be domiciled in Ireland with an expected tax rate of 17-18%.

AGN shareholders will receive 11.3 shares of Pfizer PLC for each AGN share and Pfizer shareholders will receive one share of Pfizer PLC for each current PFE share. The company estimates the merger will be neutral to Pfizer PLC’s earnings per share (EPS) in 2017, accretive to EPS in 2018, greater than 10% accretive in 2019 and accretive in the high teens in 2020.

Potential Return:
Pfizer, is a widely held dividend paying company trading at this time for about $30.50/share and AGN is trading at $298/share. This wide spread gives us an opportunity to buy Pfizer indirectly through the Allergan shares at the discount. Assuming the deal is completed and the AGN shares are converted to 11.3 new PFE PLC shares the cost of the Pfizer will be effectively $26.37/share ($298/11.3=$26.37) vs. the current market price of $30.50/share. This is a potential gain of about 16%.. For income oriented investors PFE currently pays a $1.20/share dividend per year yielding 3.9%. Management indicates the dividend will remain the same. Calculating the yield on the discounted price of $26.37, the cost of the converted PFE shares, the yield will be about 4.6% ($1.20/$26.37=4.6%) on the new Pfizer PLC shares effective cost of %26.37.

More Upside Potential:
For the patient investor this could lead to further gains over time. Using Morningstar’s [Source] fair value estimate for both companies five star Allergan is estimated to have a fair value of $370/share and five star Pfizer a fair value estimate of $38/share. Morningstar’s five star rating indicates a good price to consider purchasing the shares. Assuming the merger closes as planned the accretive earnings of the combined company should only enhance the “new” Pfizer PLC fair value above the $38/share fair value. If we elect to hold the new PFE shares, and conservatively assume the $38 fair value of the “old” PFE fair value. Our capital gain potential is about 44% if we hold it until it reaches Morningstar’s fair value estimate.

What’s the Downside?
The downside is the deal isn’t completed. It the merger isn’t completed, we are left with the Allergan shares, and can wait for AGN to reach Morningstar’s fair value of $370/share for a 24% gain over today’s price of $298 per share. Alternatively we wait for another company to acquire Allergan at something closer to its fair value as Valeant recently tried to do before Pfizer entered the picture.

On a separate note; Pfizer plans to implement a $5 billion accelerated share repurchase program in the first half of 2016 with $5.4 billion remaining under its previously announced repurchase authorization. Share repurchases can be another indication a company is selling below its fair value.

Disclosure: Long AGN

You are encouraged to do your own independent research (due diligence) on any idea discussed here because it could be wrong. This is not an invitation to buy or sell any particular security and at best it is an educated guess as to what a security or the markets may do. This is not intended as investment advice, it is just an opinion. Consult a reputable professional to get personal advice that meets your specialized needs of which the author has no knowledge. This communication does not provide complete information regarding its subject matter, and no investor should take any investment action based on this information.

 

 

Comments

  1. does treasury department news impact investment thesis?

    • Hello Y,

      Thank you for the comment. It’s a good question and below are some thoughts.

      Following the Department of Treasury notice Pfizer and Allergan released the following statement: http://www.allergan.com/news/news/thomson-reuters/pfizer-and-allergan-issue-statement “We are conducting a review of the U.S. Department of Treasury’s actions announced today. Prior to completing the review, we won’t speculate on any potential impact.” The companies involved need more time to evaluate the potential impact so it follows we would only be speculating on how it may impact the investment thesis.

      What we do know is Allergan, prior to the announced merger with Pfizer was valued by some analysts in the $350 per share range. Pfizer’s offer also tends to support this value range (11.3 Pfizer shares at $31/Pfizer share = $350/Allergan share). In effect the Allergan price below $300/share discounted the deal going through and gave us an attractive entry price.

      This discount offered an attractive entry price regardless of the outcome because if the pre merger estimates are reasonable, we’ll eventually get to $350/share for Allergan with or without Pfizer either through standalone growth or another suitor. According to the merger agreement: http://www.sec.gov/Archives/edgar/data/78003/000119312515385453/d70588dex21.htm
      if either company terminates the deal “due to an adverse change in law,” they pay the other party a termination fee of $400 million.

      Allergan share price in after hours trading dropped about 20% to about $220/share. It’s interesting that buying Allergan at $220/share would offer a potential 60% return assuming the premerger estimates were reasonable at about $350/share. That’s higher than the our estimated investment thesis return of about 44%. It’s hard to see downside from this level and I’m holding my Allergan shares.

      Disclosure: Long Allergen

  2. nicholas says:

    Hi There:

    I am reading the 10-Ks for Allergan, however I have a hard time comprehending the adjustments for Non-GAAP Earnings a.k.a Cash EPS. What makes you think that the Cash EPS is justified? Also what are your thoughts on Valeant? Since the bondholder filed intent to default, I think it provides a compelling valuation at this price point and even after the expected decline that will take place tomorrow due to the news.

    Kind Regards,
    Nicholas

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  1. […] are reasonable at about $350/share. That’s higher than the our estimated Investment Thesis [Source] return of about 44% if the merger goes through. It’s hard to see downside from this level […]

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