Who loses in biopharma as Treasury moves to block tax inversions?

Treasury Secretary Jacob Lew

As promised, the U.S. Treasury has changed the tax rules related to tax inversions in a move aimed at throwing up a roadblock on the road to lower tax rates abroad. And the move doused shares of AstraZeneca, Shire and others which had either been in the crosshairs of a potential inversion gambit or were waiting to complete the paperwork.

The government's response to inversion mania will have a big impact on the global biopharma industry, which has enthusiastically seized on the notion that it can slash its tax bill by taking advantage of its worldwide structure. That wasn't lost on investors waiting to cash in on AbbVie's proposed takeover of Shire. Shire stock ($SHPG) was down about 6% this morning in premarket trading while AbbVie shares ($ABBV) were off close to 5%. AstraZeneca ($AZN), which had to wrestle out of one megamerger attempt by Pfizer ($PFE) earlier this year, saw its shares decline close to 5% as speculation of a return match cooled. And the government's efforts to chill tax inversions will also likely affect Actavis ($ACT), widely viewed as Pfizer's second choice if it couldn't have AstraZeneca.

Pfizer's Ian Read had been making no secret of his continued ardor for a tax inversion deal. With the pipeline looking too lean to satisfy a growing number of analysts, moving the tax base to a friendlier business climate while picking up a new portfolio of marketed assets appeared one quick way to make a positive difference on the company ledger. But now he may have waited too long after stirring officials to take action designed to block Pfizer from a second try.

"Today, in an important first step, Treasury is announcing targeted action to meaningfully reduce the economic benefits of corporate inversions, and when possible, stop them altogether," said U.S. Treasury Secretary Jacob Lew. "This action will significantly diminish the ability of inverted companies to escape U.S. taxation.  For some companies considering deals, today's action will mean that inversions no longer make economic sense."

Some analysts, though, don't see these actions as quite the insurmountable barrier that the government is advertising. And at least one suggested that the legality of the rules may well be challenged in court.

The Obama administration had earlier noted that it needed new laws to stop tax inversion deals. But faced with an exodus abroad and a group of lawmakers in Congress now focused more on midterm elections than hurrying through a new, narrowly focused tax bill, Treasury officials got creative. The new rules are designed to stop companies from funneling tax-free money for these deals through overseas subsidiaries. Added Treasury: "It also makes it more difficult for U.S. entities to invert by strengthening the requirement that the former owners of the U.S. company own less than 80% of the new combined entity. For some companies considering mergers, today's action will mean that inversions no longer make economic sense."

Inversions became trendy at a time biopharma was entering a period of intense dealmaking. Flush with cash as the stock market saw shares surge, buyout deals grew hot in a rising wave of M&A deals. Hunting globally just made sense, and focusing on an international preserve like the U.K. or Ireland or Canada, which had all engineered low corporate tax rates to spur economic growth, became particularly attractive. 

Tax inversions were by no means restricted to the ranks of the pharma giants. Endo--which is trying to take over Auxilium ($AUXL) and block its inversion to Canada with a QLT buyout--inverted to Ireland last year. Raleigh, NC-based Salix Pharmaceuticals ($SLXP) struck a deal to buy an Irish subsidiary of Cosmo Pharmaceuticals so it could exchange U.S. tax rates for Ireland's much lower assessment. But Salix's shares were up after Bloomberg reported that Allergan is once again interested in making a move to acquire the company.

Bernstein's Tim Anderson noted that the administration's new rules aren't the kiss of death to inversions that Treasury may be hoping for. And they may well not block Pfizer. But they could slow down the pharma giant.

"We surmise that PFE still remains interested in inversion, assuming they may have already anticipated moves by Treasury, but the timing of any potential deal could be delayed as the impact (and possibly the legality!) of the new regulations are contemplated," Anderson wrote in a note Tuesday morning.

At ISI, Mark Schoenebaum added that even if the new rules do stop Pfizer from using overseas cash to buy another company, that wouldn't necessarily be enough to thwart the pharma giant at this stage of the game.

Wrote Schoenebaum: "Our current understanding is that (Pfizer) would not be able to use their ex-U.S. cash without being subject to U.S. tax. However, that does not mean the deal is dead. PFE could possibly raise more debt (which is still relatively cheap relative to equity)."

- here's the release