Re: The Beginning of the Endgame
Some important news today and, for a change, we are not at the center of attention.
About 3 weeks ago, in a long post where I described what I considered the beginning of the endgame, I started by observing that the anti-inversion crackdown, is for real; and that Allergan's belief that it is unsustainable proved insightful and relevant. Here is what I wrote:
MONDAY (9/22)
1 - Treasury Department Announcement: Normally, I don't put much short-term weight into announcements, however dramatically stated, by elected politicians, regulators, and high government officials -- by the time any of what they say becomes reality, if ever, current matters would have long resolved (one way or another), whatever rules they suggest would have been heavily defanged by the various status quo constituencies, and grandfather clauses and phase-in period would obliterate any remaining effects on such current matters. However, with Abbvie (who reportedly outbid Allergan to buy Shire for an inversion deal) initially dropping 5% on the news, the market shows it believes that this announcement will have immediate significant effect in taking the value proposition out of inversions.
Obviously, the Treasury Department announcement wasn't orchestrated by anyone in Allergan. As big a deal as the Allergan-Valeant battle is, the issue of inversions, and the current frenzy by proponents to get deals done and by opponents to stop them, is a much bigger matter (although it wouldn't surprise me if Allergan's plight, communicated through the array of elected officials that have publicly taken to defend Allergan, provided one of the many impetuses to get Treasury to act with uncharacteristic speed and resolve). Allergan was never a fan of inversions to begin with -- right from the first word of Valeant's offer, Allergan has been saying (apparently, quite insightfully) that inversion tax benefits are unsustainable. As the crackdown on inversion is becoming a reality, many playing pieces are moving Allergan's way: Foreign companies Allergan would be interested in buying are now less likely to be snapped up at premium pricing by inversion-seekers (as with Shire -- much as Abbvie may now regret "winning" this bid); domestic companies are less obsessed with finding an inversion themselves and thus more available to sell to Allergan for a realistic price (as with Salix, who is apparently dumping the already-signed Cosmo inversion deal to be acquired by Allergan); and, companies (foreign or domestic) that would consider bidding against Valeant for Allergan (such as Actavis), are too, not distracted by the inversion obsession (such as a Pfizer inversion bid for Actavis, apparently now dormant). Since the new rules are not yet announced, we don't know if they'll specifically and directly damage the tax saving component of the Valeant-proposed merger (an important constituent of the overall value-creation Valeant is claiming the merger will achieve), but even if not, the atmosphere of a forceful inversion crack down is damaging the credibility of any sustainable tax benefit Valeant is claiming.
By correctly foreseeing -- against the overall market sentiment, and certainly Valeant's position -- that inversions tax benefits are unsustainable and will be cracked down upon sooner than most thought possible, Allergan's board placed itself in a superior negotiating position with respect to all counter-parties that obsessed themselves with inversions! (opinion)
(Note: I'm liberally using the word "inversion" to describe all corporate transactions that have the intended effect of reducing overall tax load by expatriating the tax home of a US corporation -- to include the Valeant proposed merger, Abbvie buying Shire, Salix deal to buy Cosmo, and Pfizer talks to buy Actavis).
Well, today, the other shoe dropped. AbbVie may use circumspect language saying that the are merely 'reconsidering' the Shire inversion deal; but the market is clearly interpreting these words as the end of that deal. Shire dropped $74 (30% !!!) in one day; sending it right back to where they were before the deal. (BTW, not that we ever rejoice in the losses of those who jumped to help Ackman, ok, just a little, but Paulson lost about $1B just today on this event and it's consequences).
This event is not to be underestimated. After the collapse of the borderline-hostile takeover attempt by Pfizer against Astra Zeneca, this was going to be the largest takeover of the biggest M&A year in decades. With this supposedly done-deal collapsing -- and a whole slew of smaller deals, like the Salix-Cosmo inversion, also cratering -- it is turning into a bust. All the merger-happy stocks took a huge hit, as it became clear that there might not be that many mergers after all. Allergan, at one point, was down $15 (before recovering to down $4). To be fair, it was a heavy down-day on Wall Street altogether, but the drops for the in-play pharma shares dwarfed the broad market declines.
So what does all this mean to the Valeant-Allergan deal: Basically, as stated in the quoted post, just more vigorously so. All those companies, foreign and domestic, that were obsessed with inversion, if they didn't take the news of the bursting of the bubble seriously enough 3 weeks ago; surely are doing so now. A 30% drop in one day, wiping out about $16B in market cap, will get anyone's' attention. This broaden the playing field dramatically for Allergan. Even Shire, which was rumored to be Allergan's first acquisition interest to block Valeant, is now available at, presumably, a much more realistic price (I must note here that Allergan's Board is again proven to have been remarkably disciplined when -- as desperate as they were to kill the Valeant deal -- did not overbid for Shire and allowed AbbVie to "win" the bid. Should Allergan choose to now go pick up the pieces, they could probably buy Shire for a lot less than where the bidding was then).
In addition, with the whole M&A frenzy suddenly hitting a deep freeze, hedge funds, which pride themselves with being the first to jump out of any souring situation, are heading for the exit door (as speculated by analysts, such as BMO). And, finally, Valeant's offer -- and their entire acquisition-heavy business plan -- with the strong element of tax inversion to support their value Creation claims, is losing further steam. I wouldn't be surprised if their propaganda will begin saying what a great stand-alone company they are. (To be fair, the announced anti-inversion rules thus far do not affect foreign buyers, such as Valeant; but the anti-inversion climate is a huge risk-factor to any business model that presume sustainable tax benefits).
Dan.
