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Pharmaceutical Saga

Consider today the Pfizer/AstraZeneca saga. To anyone minimally informed on the topic it is, to say the least, a kind of nerve-racking and stress test (with asset quality guaranteed…) state of affairs!

The issue became a matter of political dispute, which isn’t a good predicament for good business practice. And then there is a scientific perspective also, that adds further to the smog.

A conflict of interest is inevitable in this deal: it is a pure big Tax arbitrage opportunistic one but on the other hand the British shareholders and wider taxpayers want to protect their interests, both financially and politically with the advantage that accrues to all Society of having good Research&Development projects being done on the UK jurisdiction.

FT’s James Mackintosh, writing in Alphaville, bluntly states (emphasis mine) what at first glance seems obvious:

” Both sides are wrong, for the right reasons. They are wrong because both sides have forgotten what capital markets are for.

To understand this one needs to understand the strange nature of the Pfizer deal. It is happening purely because of the dysfunctional interaction of the UK and US tax regimes.

The US has a deeply unattractive corporate tax regime, with a headline rate the highest in the developed world at 35 per cent – albeit riddled with loopholes for special interests – and levies tax on foreign profits only when they are repatriated. For a multinational able to move to a lower-tax country such as Britain (or even Ireland), it seems an obvious way to boost profits for shareholders.

But the US will only allow Pfizer to shift its tax domicile to Britain (easily, at least) via a takeover involving existing shareholders owning less than 80 per cent of the new company.

The deal only makes sense with the benefit of the UK tax regime. Pfizer’s tax bill will be reduced directly, it will be able to use the even-lower tax UK “patent box” system, and cash it builds up outside the US can be brought back to HQ without tax.

Go back to why markets matter. Markets don’t have some magical quality which makes them innately good (or, indeed, evil). Markets are simply the best way found so far to balance supply and demand, allocating capital to new projects in a way far better for the economy than the opposite extreme, the communist five-year plan.

Markets are not perfect. Even an entirely free market will swing between excessive optimism and excessive pessimism about new ideas – as in the dotcom bubble. There may be cases where governments can intervene to damp such excess, although I remain doubtful about how to keep politics out.”

It seems that there are some loopholes in the above argument about the US tax system. But the main point is about the question of Market forces, shareholders & management incentives and efficiency. The normal rule of good investment practice, that precludes excessive Government interventions and regulation, might in cases as this be balanced with a proper and rigorous account of the right wider Society welfare. Which is far from easy. Is it always true that maximizing efficiency and shareholder value will inevitably turn in greater welfare…

Further down, again Mr. Mackintosh:

M&A should as a matter of course be left to the market. Shareholders should be allowed to be “short-sighted”, as the FT leader put it, if they so wish. They will lose out, and competitors with a different view can pick up the profits being ignored by those shareholders. Governments which try to stop the suffering will end up protecting those industries which shout the loudest.

But when M&A only happens because of governments, governments are right to stop it.

This is one of those cases: the US and to a lesser extent the UK have distorted the system. The immediate losers will be workers and scientists at both Pfizer and AstraZeneca, along with US taxpayers. But in the long run we all suffer, as the market is allocating capital inefficiently, and that means slower economic growth than would otherwise be possible.

As matters unfold the deal came to a standstill, the final offer by Pfizer of £55 per share was denied, which valued AstraZeneca at £69.4 bn. And there is a game of blame each other for the possible failure. The deadline is approaching. Let’s hope for the best:

‘Under UK takeover rules, Pfizer is not allowed to increase its offer or launch a hostile bid because it declared its £55 proposal final and said it would proceed only if the bid was recommended by AstraZeneca’s board. However, in its statement late on Monday, Pfizer “reserved the right subsequently to increase its offer at any time”.

Some shareholders took this to mean that the two companies could agree a recommended £55-per-share deal as a first step towards a higher price. The May 26 deadline could be extended at AstraZeneca’s request, if it agreed to resume negotiations.

People close to AstraZeneca say the UK company saw Pfizer’s statement as an attempt to sow confusion and foment rebellion against its board.

AstraZeneca issued its own statement, saying: “Pfizer’s final proposal, which the board rejected, is not capable under the Takeover Panel rules of being increased or even suggested at being increased, privately or publicly.”

Indeed, let’s hope for the best outcome possible.

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