The (failed) Acquisition of Allergan by Pfizer. Multiples Valuation and Event Study Analysis

Bachelor Thesis, 2017

32 Pages, Grade: 2,0


Table of Contents

The (failed) Acquisition of Allergan by Pfizer

List of Abbreviations

List ofFigures

1. Introduction

2. Multiples Valuation
2.1 The pharmaceutical industry
2.2 Comparable Companies
2.3 Multiples Selection and Results

3. Transaction Multiples Valuation
3.1 Comparable Transactions
3.2 Multiples Selection and Results

4. Event Study Analysis - Merger
4.1 Parameter Selection
4.2 Results

5. Event Study Analysis - Termination
5.1 Parameter Selection
5.2 Results

6. Conclusion



List of Abbreviations

Abbildung in dieser Leseprobe nicht enthalten

List ofFigures

Figure 1 Mergers & Acquisitions - Biotechnology & Pharmaceuticals

Figure 2 Decomposition of Allergan transaction value

Figure 3 Therapeutic Areas in Pipeline Products

Figure 4 Allergan Standalone Multiples Valuation

Figure 5 Allergan Transaction Multiples Valuation

Figure 6 Event Study Merger - Pfizer

Figure 7 Event Study Merger - Allergan

Figure 8 Event Study Merger - Peers

Figure 9 Event Study Merger - Cumulative Abnormal Returns

Figure 10 Relative Stock Performance - Merger

Figure 11 Event Study Termination - Pfizer

Figure 12 Event Study Termination - Allergan

Figure 13 Event Study Termination - Peers

Figure 14 Event Study Termination - Cumulative Abnormal Returns

Figure 15 Relative Stock Performance - Termination

Appendix 1 Decomposition ofPeer Group Multiples

Appendix 2 Decomposition ofPeer Transaction Multiples

Appendix 3 Abnormal Returns Event Period - Merger

Appendix 4 Cumulative Abnormal Returns Event Period - Merger

Appendix 5 Abnormal Returns Event Period - Termination

Appendix 6 Cumulative Abnormal Returns Event Period - Termination

1. Introduction

Even though the pharmaceutical industry is in steady change and experiences thousands of mergers and acquisitions (M&A) deals per year (Fig. 1), the proposed fusion of the two biopharmaceutical corporations, Pfizer Inc. (Pfizer, PFE) and Allergan pic. (Allergan, AGN), stood out when it was announced on November 23rd, 2015 (Pfizer Inc., 2015).

On the one hand, the merger would have been not only the biggest to ever be completed in the pharmaceutical industry but also the third largest in economic history by deal value (IMAA Institute, 2017b). The two firms “agreed to combine [...] in a stock transaction valued at $363.63 per Allergan share, for a total enterprise value of approximately $160 billion” (Pfizer Inc., 2016a, p. 2), which, furthermore, represented a premium of more than 25% on Allergan’s stock price before the companies announced to be in talks on October 29th, 2015 (Allergan pic., 2015b). The transaction would also have created the largest pharmaceutical company in terms of revenue in the world (ThomsonOne, 2017b).

On the other hand, the combination was structured in a way to circumvent United States (US) laws on corporate inversions. Pfizer shareholders were assumed to own 56% of the new, Ireland-based parent firm and Allergan shareholders 44% respectively (Groden & Smith, 2015). Therefore, the transaction was expected by the involved parties to be unaffected by the changes in US tax law the Treasury Department declaredjust days before the announcement (U.S. Department of the Treasury, 2015) and the new enterprise to be treated as a foreign corporation for US federal income tax purposes (Pfizer Inc., 2016a, p. 2). As I will conclude, this had a main impact on the pricing of Allergan as Pfizer hoped to save billions of dollars in tax payments on future profits as well as on the repatriation of foreign income (de la Merced, Gelles, & Picker, 2015).

In the first chapter of this bachelor thesis I will examine whether the price the boards of directors of the two firms agreed upon was fair by valuing Allergan using standalone multiples at the time of the merger announcement. Firstly, I will briefly discuss the current state in the pharmaceutical industry and distinguish between two possible business models for firms in this sector. Since M&A have an increasingly important role in the corporations’ strategies, I will explain their character and provide reasons for this trend. Afterwards, I will characterize Allergan as a research-based organization and, in the next step, identify its key competitors by assessing business strategies and areas of operation. The group of comparable companies for the following multiples valuation will consist only of research-based pharmaceutical firms with a relatively diversified product pipeline. Furthermore, I will provide reason for the selection of multiples and, at the end of the chapter, show that the price to be paid would have been disproportionately high and Allergan overvalued when just considering standalone multiples. However, expected synergies in terms of substantial tax cuts seemed to be a possible reason for the high price.

Therefore, as a second step in the overall analysis of this merger case, I will perform a valuation of Allergan using transaction multiples of previous, comparable M&A deals to adjust the preceding results for these possible synergies. The obtained outcome will provide estimations closer but still lower compared to the proposed price. Thus, Pfizer would have overpaid for Allergan. However, I will argue that the relatively significant difference between actual price and multiples valuation results from the exceptional, immediate tax benefits and that the deal could have been advantageous for Pfizer anyway.

In the third part of this thesis, price reactions following the combination announcement in the stocks of Pfizer, Allergan, and the comparable companies previously identified will be examined using an event study analysis. At first, I will explain how the estimation and event period were set and which methods were used in the calculation of abnormal returns. The analysis will demonstrate that Allergan’s shares reacted positively immediately but then rose insignificantly and did not reach their conversion value which indicates that the market had not been convinced of the completion of the merger. On the other hand, Pfizer’s stock remained relatively unaffected but accumulated a negative abnormal return of over 7.7% during the event period. Thus, I will conclude that these findings underline the overvaluation of Allergan as indicated in the multiples estimations. Moreover, total prices reactions in the comparable companies were statistically insignificant which contests my presumption of a competitive benefit for the involved parties in this merger.

As a fourth chapter of my thesis, I will perform another event study analysis to assess the stock price reaction that followed the release of changes in the treatment of inversion deals by the US Treasury (U.S. Department of the Treasury, 2016) which eventually led to the termination of the fusion (Pfizer Inc., 2016c). This termination alone signposts the tax benefits as the main driver of the deal. However, I will show that Pfizer shares experienced an upward movement whereas Allergan’s dropped significantly which further supports the preceding argument that Pfizer offered too much by market standards.

In the end, I will argue that the transaction could have still been beneficial for Pfizer due to the special circumstances of high tax cuts and the ability to repatriate its foreign profits at substantially lower costs but, only considering the results of the multiples valuation and event studies, Pfizer would have overpaid if the merger had been completed.

2. Multiples Valuation

2.1 The pharmaceutical industry

The underlying assumption of a multiples valuation is that the corporations, from which the multipliers are calculated, are truly comparable to the enterprise being valued. Therefore, the industry in which the enterprise operates is usually taken as a starting point since those businesses often “resemble the target firm along important value attributes, such as growth and risk” (Lui, Nissim, & Thomas, 2002, p. 136).

In general, there are two business models in the pharmaceutical industry. One is to perform extensive research in order to develop drugs based on new chemical entities which either enable to cure diseases that could not have been healed before or enhance existing therapies (e.g. AstraZeneca pic., 2017, p. 2). As these developments have a success rate of just 4% from ‘first toxicity dose’ to market (Thomson Reuters, 2014), newly established drugs then must generate sufficient revenues and profits to compensate all the other failed R&D activities. Thus, these research-based firms rely on patent protection and intellectual property laws to shield those products from being copied. In the pharmaceutical industry, these copies are so-called generics which are “identical [...] to a brand name drug in dosage form, safety, strength, route of administration, quality, performance characteristics and intended use” (U.S. Food & Drug Administration, 2015).

Generic drugs are at the cornerstone of the second possible business model. Its manufacturers are waiting for patents to expire or even challenge patent protection to open the market for their products which are usually supplied at reduced prices compared to brand medicibes. They “save consumers an estimated $8 to $10 billion a year at retail pharmacies” and even more in hospitals (U.S. Food & Drug Administration, 2015).

As stated before, the pharmaceutical industry is in steady change. Since 2006 there have been on average over a thousand M&A deals per year in the biotechnological and pharmaceutical sector with aggregated transaction values reaching over US Dollar (USD) 500 billion (bn) in 2015 (Fig. 1). Pfizer alone accounted for eleven deals worth more than USD 17bn in2015 (ThomsonOne, 2017a).

Fig. 1 Mergers & Acquisitions - Biotechnology & Pharmaceuticals

Abbildung in dieser Leseprobe nicht enthalten

Source: IMAA Institute. (2017a, May 20). M&A by industries. Retrievedfrom

These high figures can be explained by industry specifics. One important factor are extensive regulatory requirements. For each country, a pharmaceutical firm wants to patent and sell their medicine in, it needs to seek approval from the regulatory authorities. In order to receive such permission, preclinical and clinical trials have to be conducted during the research and development (R&D) process to show safety and efficacy of each drug (Allergan pic., 2016a, p. 17). Depending on the development phase, these studies cost millions of dollars and are the “most resource intensive part” (Battelle Technology Partnership Practice, 2015, p. 1) in the entire procedure as hundreds of human volunteers are needed in each of five study phases which cost on average USD 36,000 per person (Battelle Technology Partnership Practice, 2015, pp. 5-6). Thus, many small and innovative pharmaceutical firms do not have the financial capacities to perform those trials on their own and either cooperate with larger, more resourceful corporations or even sell them their whole business.

Another factor leading to the high number of deals and especially the skyrocketing transaction values of 2014 and 2015 is a trend of consolidation and focus. On the one hand, industry leaders are buying smaller firms as described above to improve their pipeline of new medicines in therapeutic growth areas like oncology, diabetes and autoimmune (IMS Health, 2016, p. 7) with 29% of all therapeutic licensing and acquisition deals made in oncology from 2006 to 2015 (Biotechnology Innovation Organization, 2016, p. 9).

On the other hand, enterprises are also divesting business units which are not part of their strategic core areas. For instance, at the beginning of 2015 Novartis AG (Novartis, NVS) sold “its Animal Health business for USD 5.4 billion” (Novartis AG, 2017, p. 153) to Eli Lilly & Co. (Eli Lilly, LLY). These divestures are mostly driven by the industry’s ambition to improve the efficiency of R&D activities (Novartis AG, 2017, p. 150) and, consequently, earn even higher profit margins. This furthermore results in more cooperation between pharmaceutical firms as well as with non-corporate institutions which leads to even more licensing deals (Bristol-Myers Squibb, 2016, pp. 36-46).

2.2 Comparable Companies

Considering this market environment and the high valuation of Allergan as decomposed in Figure 2, I took the ten largest publicly listed, pharmaceutical firms by market capitalization excluding Pfizer as a starting point for this peer group.

Fig. 2 Decomposition ofAllergan transaction value

Abbildung in dieser Leseprobe nicht enthalten

Sources: Allergan pic. (2015). Q3 2015 Results.; Allergan pic. (2016). 2015 Form 10-K.; Pfizer Inc. (2016). 2015Financial Report.;wrds. (2017, May 10). CRPS daily stock.

In detail, these are Roche Holding AG (Roche, ROH), Novartis, Merck & Co. (Merck, MRK), Sanofi SA (Sanofi, SAN), GlaxoSmithKline pic (GSK), AbbVie Inc. (AbbVie, ABBV), Bristol-Myers Squibb (BMY), Gilead Sciences Inc. (Gilead, GILD), Eli Lilly, and AstraZeneca pic (AstraZeneca, AZN) (OnVista, 2017).

Generics manufacturers like Teva Pharmaceutical Industries Ltd. (Teva) have not been considered in this multiples valuation, because the divesture of Allergan’s generics segment had been a requisite for the merger with Pfizer (Pfizer Inc., 2016a, p. 2). Furthermore, all these companies as well as Pfizer and Allergan can be characterized as above mentioned research-based businesses. They all invest significant a share of their revenues in the search for new medicines. For instance, in 2015 Eli Lilly spend 24% of its sales on R&D activities (Eli Lilly & Co., 2016, p. 8). Cost of goods sold, however, are relatively low and the firms achieve gross margins up to 88% at Gilead in 2015 (ThomsonOne, 2017b).

Fig.3 TherapeuticAreas ofPipeline Products

Abbildung in dieser Leseprobe nicht enthalten

Sources:AbbVieInc. (2016). 2015AnnualReportonForm 10-K.;Allergan pic. (2016). 2015Form 10­K.; AstraZeneca pic. (2017). Annual Report and Form 20-Flnformation 2016.; Bristol-Myers Squibb. (2016). 2015Financial Report.;EliLilly& Co. (2016). 2015AnnualReport andProxy Statement.;F.

Hoffmann-La RocheLtd. (2017). Roche in Brief2016.; GlaxoSmithKline pic. (2017). AnnualReport 2016.; Merck& Co., Inc. (2017). Form 10-K2016.; NovartisAG. (2017). 2016AnnualReport.; Pfizer Inc. (2016). 2015FinancialReport.; Sanofi SA. (2017). Form 20-F 2016.

As a pharmaceutical company’s pipeline is most important for its future growth, specialty firms like Vertex Pharmaceuticals Inc. which participate only in one or two therapeutic areas in terms of R&D (Vertex Pharmaceuticals Inc., 2017) have also been excluded from this peer group as they typically involve higher return uncertainty.

Moreover, Figure 3 shows this group consists of relatively diversified organizations with regard to the therapeutic areas of their pipeline products which are aligned with their current portfolios. However, they are all heavily invested in at least two of the top five medical spending areas of 2021 (IMS Health, 2016). It is, for example, estimated that by then a minimum of USD 75bn will be spend on just curing pain (IMS Health, 2016). Therefore, the peer group companies have high growth potentials if they successfully develop innovative medicines to solve unmet medical needs in such areas.

Nevertheless, the firms also face several risks inherent in their business model. High competition from generics manufacturers as described above, represents a serious threat to the earnings power of research-based corporations as the loss of exclusivity is usually followed by a sharp drop in sales (e.g. Eli Lilly & Co., 2016, p. 40). Additionally, governments foster price competition either to ensure “[ajccess to affordable medicines and vaccines on a sustainable basis” (World Health Organization, 2016, p. 38) or to contain costs of national healthcare insurances as seen in Germany (Federal Ministry of Health, 2017).

Because of their shared business model, for the purpose of this multiples valuation the above-mentioned companies are assumed to be truly comparable and can be characterized by the same general growth prospects and immanent risks.

2.3 Multiples Selection and Results

Since product exclusivity is the main driver of revenues and profits at the research-based pharmaceutical companies in this sample, past results are not very meaningful with regard to their future earning power and, correspondingly, their market valuation. Therefore, I only considered forward-looking measures in this multiples analysis. Additionally, I chose IBES earnings over COMPUSTAT earnings, because research has shown they perform better in terms of pricing errors as they adjust for one-time events (Lui, Nissim, & Thomas, 2002, p. 137).

Specifically, I derived analysts’ one-year forecasts on earnings per share (EPS), cash flow per share (CPS), earnings before interest and taxes (EBIT), earnings before interest, taxes, depreciation and amortization (EBITDA), and sales. These are also the most commonly used value drivers in multiples valuation. However, I did not include any book value measures as Allergan accounts for extraordinary high goodwill (ThomsonOne, 2017b) due to its preceding M&A activity.

In the case of a minor data lack, I made own estimates using the publicly available financial data. Unfortunately, I had to exclude Roche completely from the valuation, because there was no data available for this organization in the Wharton Research Data Services (wrds).

Fig. 4AllerganStandalone Multiples Valuation

Abbildung in dieser Leseprobe nicht enthalten

Source: Own calculations - For the decomposition ofthe peer group multiplesplease see Appendix 1.

Based on those forecasts, I computed Allergan’s equity value using the price/earnings (P/E) and price/free cashflow (P/FCF) ratios as well as the enterprise value via EBITDA, EBIT and sales multiples. As Figure 4 shows, the standalone multiples value Allergan far below the price Pfizer offered independent of the metric used with equity values between approximately USD 87bn and USD 107bn. Enterprise values are distributed even broader, ranging from USD 75bn up to USD 131bn which, however, is still about USD 25bn below the price Pfizer would have paid.

These results indicate that Pfizer either would have overpaid and, thus, harmed its shareholders or the synergies inherent in the combination would have been sufficient to compensate such a price premium.

For instance, cost savings of USD 2bn per year for the first three years had been expected (Groden & Smith, 2015). However, the major value drivers in this particular case would not have been the typical increased efficiency, but instead a major tax cut for Pfizer due to the relocation to Ireland following the fusion (de la Merced, Gelles, & Picker, 2015). While Pfizer paid an effective tax rate of 25.5% in 2014 (Pfizer Inc., 2016a, p. 19) its international rivals paid significantly less. For example, Switzerland-based Novartis had a core tax rate of just 14.6% during the same year (Novartis AG, 2017, p. 152). In comparison, Ireland has a corporate tax rate of just 12.5% and even “allows a reduced 6.25% tax rate on profits from” specific R&D assets (Deloitte, 2016, p. 5) which might have given the combined firm a competitive edge.

Moreover, Pfizer had and still has several billions of profits accumulated outside of the US and, thus, built a deferred tax liability of over USD 20bn (ThomsonOne, 2017b), of which a major part could have been saved due to Ireland’s investor-friendly tax laws (Deloitte, 2016, p. 5). The two organizations even included provisions in their definite merger agreement allowing both to terminate the transaction if regulation changes “causefd] the combined company to be treated as a U.S. domestic corporation for U.S. federal income tax purposes" (Allergan pic., 2016a, p. 47). This further underlines the exceptional importance of tax benefits in this case.

Additionally, Pfizer had already tried to take over AstraZeneca in 2014 in its efforts to relocate the firm to a lower tax jurisdiction (Berkrot & Hirschler, 2014). At the time, the deal mainly failed because of the comparably low price premium Pfizer offered (Berkrot & Hirschler, 2014) which could have contributed to the management’s decision to offer more in the Allergan transaction.

3. Transaction Multiples Valuation

3.1 Comparable Transactions

In the following I will present the results of the transaction multiples valuation for which I evaluated four comparable M&A deals between publicly listed, research-based pharmaceutical companies. In detail, these were in 2008 Roche’s takeover of Genentech Inc. (DNA), in 2009 Pfizer’s acquisition of Wyeth Corp. (WYE) and Merck’s fusion with Schering-Plough Corp. (SGP), and in 2014 Actavis pic.’s (Actavis) deal with Allergan (App. 2). All these firms have been relatively diversified at the time of the respective transaction and with the Actavis-Allergan merger even another inversion is included in the sample.

However, I excluded takeovers of specialty pharmaceutical firms such as AbbVie’s acquisition of Pharmacyclics Inc. (AbbVie Inc., 2016, p. 70) or Actavis’ buyout of Forest Laboratories Inc. (Allergan pic., 2016a, pp. 7-8). These firms have not been as diversified as Allergan at the time of the merger proposal with Pfizer and, therefore, have a different risk/reward profile which makes them non-comparable transactions.

3.2 Multiples Selection and Results

To make the findings comparable to those of the previous standalone multiples valuation, I used the same data sources, forward-looking measures, and metrics.

Fig. 5 Allergan TransactionMultiples Valuation

Abbildung in dieser Leseprobe nicht enthalten

Source: Own calculations - For the decomposition of peer transaction multiplesplease see Appendix 2.

The higher valuations as presented in Figure 5 are in line with the assumption explained earlier that transaction multiples are adjusted for general synergy effects resulting from most mergers. Nevertheless, the estimations are still significantly lower than the price Pfizer would have been willing to pay, especially, when using the harmonic mean which performs best in terms of pricing errors as a study of Lui, Nissim, and Thomas (2002, p. 5) has shown. Hence, Pfizer would have overpaid for the merger with Allergan even when considering synergies.

However, the deal could have been beneficial for Pfizer even though the price would have been too high. This is due to the unprecedented cost savings on the repatriation of foreign profits which might have added up to over USD 20bn (ThomsonOne, 2017b). In order to conscientiously adjust the evaluation of the transaction for these tax benefits would require an in-depth analysis of the Irish tax laws and its impact on the future cash flows of the combined company which is beyond the scope of this thesis.

Another price driver in this fusion could have been Pfizer’s plans to split up the combined company in two separate businesses in the future with one consisting of the innovative activities including the firms pipeline and the other one marketing the lower margin established products (Pfizer Inc., 2016c). This might have left Pfizer with only a few options for a possible M&A deal and, thus, increased the price Allergan demanded.

4. Event Study Analysis - Merger

4.1 Parameter Selection

Based on the assumption of an overvaluation of Allergan, I will now assess the effect of the announcement of the definite merger agreement on November 23rd, 2015 on the stock prices of the involved parties and their key competitors. Therefor I will analyze whether there have been significant abnormal returns (AR) and what the implications of those might be. The underlying assumption of any event study is an efficient market “in which prices always "fully reflect" [all] available information” (Fama, 1970, p. 383) because otherwise daily stock returns would have no implications at all.

The event period chosen for this study starts with the first day Pfizer and Allergan made public to be in talks on October 29th, 2015, and ends ten trading days after the announcement of the definite agreement. Due to Allergan’s announcement of the disposal of its generics business to Teva for approximately USD 40.5bn (Allergan pic., 2016a, p. 3), I selected the estimation period to go back only to August 5th, 2015 so the study’s results would not be affected by the transaction.


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The (failed) Acquisition of Allergan by Pfizer. Multiples Valuation and Event Study Analysis
University of Mannheim
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Corporate Finance, M&A, Multiples Valuation, Event Study
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Oliver Terhechte (Author), 2017, The (failed) Acquisition of Allergan by Pfizer. Multiples Valuation and Event Study Analysis, Munich, GRIN Verlag,


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