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.
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.
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
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