Government Bites Merger, Merger Bites Dust

DRUGMAKER PFIZER’S DECISION to terminate its proposed merger with Irish firm Allergan shows that the federal government does have the ability to prevent market consolidation and blatant tax avoidance — if it just displays a little aggressiveness.

The Pfizer/Allergan merger was structured as an inversion, a popular tax dodge where a larger U.S. company (Pfizer) buys a smaller foreign counterpart (Allergan) and shifts its headquarters abroad. In this case, Pfizer sought to take advantage of Ireland’s 12.5 percent tax rate, far smaller than the U.S.’ 35 percent. Pfizer would also have gotten access to roughly $50 billion in earnings it has stashed overseas to avoid U.S. taxation.

But the Obama Treasury Department issued new rules on Monday targeting inversions, one of which appeared to be explicitly aimed at the Pfizer/Allergan deal. Specifically, Treasury focused on “serial inverters” — companies like Allergan that have engaged in multiple inversions. Actavis merged with Allergan last year, and before that, Allergan consummated five other acquisition deals since 2012.

Under the new regulation, serial inverters have their previous three years of acquisitions canceled out when measuring their size under the tax code.

This obliterated Pfizer’s case for merging with Allergan. Inversions hold maximum value for the bigger company when they end up with around 60 percent of merged shares. Under the government’s new tax treatment, Pfizer would have owned well over 80 percent. That would have completely eliminated the tax benefit — because previous inversion rules designate companies with over 80 percent of total shares as still U.S. corporations under the tax code, even if they move their headquarters abroad.

Clearly, Pfizer saw no further benefit to merging, as its board voted Tuesday night to kill the deal. As part of the agreement, Pfizer must also pay Allergan a breakup fee that could total as high as $400 million, though it’s likely to be closer to $200 million.

The government issued two prior versions of anti-inversion steps that didn’t include the serial inverter rule. After the first set of rules, former White House economist Jared Bernstein called them “but a speed bump on the international tax avoidance highway.” The rules were seen as too weak to stop foreign mergers, and while most agreed that only congressional action could truly stop the practice, many saw a role for the executive branch to step up.

The day the Pfizer/Allergan merger was announced, Bernie Sanders insisted, “The Obama administration has the authority to stop this merger, and it should exercise this authority.”

Sanders was likely referring to authority under antitrust laws to reject mergers that reduce competition. But the administration found another way to frustrate the $150 billion deal, by making it unprofitable.

And while Pfizer could have fought the serial inverter rule on the grounds that the Treasury Department overstepped its regulatory authority, CNBC reported that the company didn’t want to risk litigation against the government.

This type of aggression in blocking mergers is precisely what has been lacking from the administration’s antitrust agencies in their first several years. As a result, industries consolidated without much resistance. Senators from both parties criticized the Justice Department and the Federal Trade Commission for their impotence just a few weeks ago.

While the new rules probably won’t prevent all inversions, they show how a determined government can fight corporate tax dodging and confront proposed mergers. And when confronted, companies hoping to merge frequently back down.

In addition, the antitrust agencies have begun to step up their activities. The Justice Department plans to sue oil-services firm Halliburton over its takeover of top rival Baker Hughes. The department is also warming to a novel theory that cross-ownership by mutual funds in competitors in the same industry limits competition.

Overall, the idea that government can protect citizens from the downsides of market consolidation is making a comeback. And that’s bad news for companies like Pfizer.

Top photo: Viagra, the drug Pfizer is best known for.