Pharmaceutical giant and Dow member Pfizer (PFE – Free Pfizer Stock Report) recently made headlines when it announced in November, 2015 that it is planning to join forces with Ireland-based Botox maker Allergan plc (AGN) in a mega merger worth a jaw-dropping $160 billion. So what does this mean for the individual investor looking to include the blue chip in a portfolio? For anyone seeking to gain insight here, the Value Line report is certainly a good place to start.
To be sure, the deal, which would potentially be the largest in pharmaceutical industry history, is complex, as it would enable Pfizer to be bought by Allergan in a tax inversion set-up, with Allergan shareholders receiving 11.3 shares of the combined entity for each AGN share held, while Pfizer stockholders would get one share for each PFE share owned. In a tax-inversion structured deal, a U.S. corporation essentially buys (or merges with) a foreign company and relocates its headquarters abroad mostly for tax advantage purposes.
Assuming all necessary regulatory and shareholder approvals are obtained and customary closing conditions are met, the transaction between PFE and AGN should be completed around the second half of 2016. Once the new entity’s domicile is established in Ireland, Allergan will end up owning 44% of the combined company and Pfizer (the acquirer) will own the majority 56% stake. The company, to be renamed Pfizer plc, would get a $1 billion tax benefit and see its tax rate decline to 17%-18%, from the current 25%. Cost synergies from the combination would also be substantial, with an estimated $2 billion in savings to be realized in the first three years, though earnings accretion would not occur until 2018. The deal and its terms, as well as its impact, are discussed in the Commentary section of the page.
Although tax-inversion arrangements have become increasingly popular in recent years, they are highly controversial and heavily scrutinized by the federal government, since they seek to take advantage of tax loopholes, and essentially place a bigger tax burden on smaller domestic firms, while layoffs are also a concern. The union between Pfizer and Allergan is no exception. Already, the mega deal has faced harsh criticism from government and political figures alike, as well as some investors.
Cutting the tax bill wouldn’t be the only positive for Pfizer, however. The proposed merger would certainly be a boon from a competitive standpoint, too. Indeed, following the loss of patent protection in late 2011 of its blockbuster cholesterol drug Lipitor, Pfizer’s other top-selling medications (Lyrica, Prevnar, Enbrel, and Celebrex) have helped to pick up some of the slack. But, as evidenced from the Statistical Array section on the Value Line page, the U.S. drugmaker’s sales and profits have started to lose steam again more recently, making an acquisition seem like a logical move in its efforts to jumpstart growth. The Allergan addition would, in essence, help expand PFE’s drug pipeline in a range of medical areas, from aesthetics and dermatology to eye care, gastrointestinal disease, and women’s health, to name a few. Moreover, Allergan’s extensive global infrastructure would give Pfizer a wider international footprint.
From the Value Line page, one might immediately notice that the Timeliness rank (found in the Ranks box at the top left corner) on Pfizer has been suspended as of early December. That’s because the stock is currently trading largely on news of the merger and not necessarily on the company’s fundamentals, making it difficult to gauge year-ahead price performance relative to the broader market indices. Right away, this should eliminate investors with a 12-month time frame from considering PFE. The stock is not an overly compelling pick for the long term, either. In fact, on a standalone basis, Pfizer’s 3- to 5-year total return potential, which factors in price-appreciation potential and prospective dividend payments is somewhat modest, as illustrated in the Projections box.
Nonetheless, the Dow equity has a number of stellar qualities that boost its appeal, including a low-risk profile. To this end, PFE boasts a top-notch Safety rank of 1 (Ranks box) and a superlative Financial Strength score of A++, shown in the Ratings section at the bottom right-hand corner of the Value Line page. These metrics largely reflect the company’s strong financial position, highlighted by solid balance sheet fundamentals that include a sizable cash hoard and a very manageable level of debt (about 30% of total capital). Stability indicators are highly favorable here, as well, with a Price Stability mark of 95 and a beta Coefficient of 0.85.
Investors might also be drawn to PFE’s income component, as the equity features a healthy Dividend Yield (located in the Top Label) at 3.7%, well above the Value Line median, while the analyst’s projection of dividend growth of about 7% (shown in the Annual Rates box) suggests decent increases are on tap out to late decade.
Pfizer stock appears to be pricey, based on its P/E ratios (Top Label), which are higher than historical levels. On the other hand, we wouldn’t necessarily dismiss the blue chip. Although we concede that the issue on its own is not cheap, and that the pending marriage between Pfizer and Allergan will be costly and needs to clear regulatory hurdles, we think there could be plenty of incentive here for investors willing to exercise some patience and take a chance, as the new Pfizer may well prove rewarding in time. Indeed, as analyst Michael Ratty points out in the Commentary “the deal is viewed as high risk and expensive, but the strategic long-term benefits are hard to ignore”.