Rumors about a massive health care deal were circulating in industry circles, months before Pfizer disclosed its $100 billion pursuit of Britain's AstraZeneca, according to several industry bankers and lawyers.
As rivals and bankers assessed what it could mean for different companies in the industry, one aspect touched nearly everyone: what it could mean for an increasingly popular U.S. tax loophole.
U.S. health care companies worried that if a household name like Pfizer changed its domicile to Britain to lower its tax rate as a result of a deal with AstraZeneca, it would spur Congress into action and close the tax arbitrage opportunity, called tax inversion, for everyone else, these people said.
The fear of such an outcome—even though it is likely many months, if not years, away—added new urgency to companies such as Botox-maker Allergan and generic drugmaker Mylan that were already looking at European targets, people familiar with these situations said.
Allergan declined to comment. Its CEO David Pyott has said that he would be uncomfortable doing a deal where the tax benefit, and not strategy, was the principal driver. Mylan could not be immediately reached for comment.
Now that Pfizer's plans are out in the open, pitching by bankers on inversion targets has reached a fever pitch. While tax arbitrage deals have so far largely been in the pharmaceutical sector, bankers and lawyers said U.S. technology, consumer and industrial companies are also now looking into the possibility of doing a tax inversion deal.
One banker, who declined to be identified because he is actively advising companies on such deals, said the Pfizer plan "will get people to try to move a lot quicker" so that they can get a deal "grandfathered in" before any possible law change.
Tax inversions allow U.S. companies, which face one of the highest tax rates in the world—a federal tax rate of 35 percent, and an overall rate that can be close to 40 percent including state and local taxes—to move to a lower-tax country by buying or creating a new holding company.
Since 2008, about two dozen U.S. companies have used the strategy, versus about the same number over the previous 25 years, according to a Reuters review of transactions.
Ireland, the Netherlands, Switzerland, Canada and Britain lately have been the most common destinations of U.S. companies seeking new tax domiciles. The U.K. tax rate for companies is due to drop to 20 percent from 21 percent next year.
This year, most of those deals have happened in health care, which is in the midst of an unprecedented bout of deal-making. More than a $153 billion worth of deals have already been announced so far this year in the sector, the highest since Thomson Reuters began tracking data. Several more are in the works, and many of those have tax arbitrage as one of the crucial drivers for the transaction as well.
As the industry had feared, Pfizer's plans have triggered concerns in Washington, with lawmakers calling for comprehensive tax reform. On Wednesday, a U.S. Treasury official said the Obama administration is seeking ways to curb tax-dodging by U.S. businesses that reincorporate overseas.
"Inversion transactions illustrate the need for comprehensive business tax reform that would lower corporate tax rates and limit the ability of multinationals to shift income outside the U.S.," the Treasury official said, noting that the administration knows such deals "are occurring and aren't being caught by the current rules."
Analysts and lawmakers say the chances of Congress passing a new law anytime before the November mid-term U.S. elections are slim given the gridlock between Democrats and Republicans over the tax reform question. They expect Congress to take up tax reform sometime next year.
"Without some kind of tax reform in this country, there are huge benefits to large multinationals re-domiciling into more tax-friendly jurisdictions," Ray McGuire, Citigroup's global head of corporate and investment banking, told an M&A panel at the Milken Institute Global Conference in Los Angeles earlier this week.
Not all arbitrage
While tax advantages have become a major driver for deals, bankers and lawyers said their clients in general are thinking of business needs first when assessing potential targets.
The frenzied dealmaking in health care comes as the industry restructures amid health care spending cuts and competition from cheap generics.
"People may be pitching clients to do inversions now because of a concern that the rules may change over time, but the companies we deal with every day are thoughtful about these things and do not just chase deals for tax purposes alone," said Gordon Caplan, a partner at Willkie Farr & Gallagher.
Buying AstraZeneca, for example, would boost Pfizer's pipeline of cancer drugs and generate significant cost savings. But it would also allow it to re-domicile to Britain and enjoy lower tax rates.
U.S. drugmaker Mylan, which has been seeking to buy Swedish drugmaker Meda, was looking to do an inversion deal because it was at a disadvantage compared to foreign generic rivals, people close to the matter said. Major competitors include Teva Pharmaceuticals Industries, which is based in Israel, and Actavis, which re-domiciled to Ireland through a 2013 acquisition of Warner Chilcott. Both face lower tax rates.
Mylan, these people said, is also worried that if it doesn't complete an acquisition, it would be bought by another company that has already completed an inversion.
Similarly, Allergan first approached Shire in recent months in part because of the tax arbitrage opportunity. But now it, too, faces the prospect of being swallowed up by an unwanted bidder, Valeant Pharmaceuticals InternationalInc in partnership with activist investor Bill Ackman. That has prompted Allergan to consider once again making a bid for Shire, despite being rebuffed when it made a previous overture, sources told Reuters earlier this week.
"There is a sense that the government will change the tax rules, when and if they get around to rewriting the tax code as they have talked about doing," said one M&A lawyer who is working on these deals and therefore did not want to be identified. "So if people want to do these deals they better do them soon."