Why Pfizer May Not Give Up On AstraZeneca

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Pfizer‘s (NYSE:PFE) decision to withdraw its bid for AstraZeneca raises questions about whether this is the end of the saga, or if one of the companies will restart the negotiations at some point. It appears that in addition to the disagreement on pricing, the way the deal was handled had a significant role in the falling out between the two companies’ boards. The final bid from Pfizer was less than 10% below what AstraZeneca deemed fair, which suggests that there is good chance that investors will pressure the companies to initiate the talks again. Pfizer has every reason to be interested in AstraZeneca given its declining R&D productivity, expected tax savings and potential cost synergies. Competitors such as Merck (NASDAQ:MRK) and Bristol-Myers Squibb appear to have more promising pipelines, and that could impact Pfizer in the near future. Sooner or later, it seems likely that Pfizer will make an acquisition and AstraZeneca seems to be a good bet.

Our price estimate for Pfizer stands at $34, implying a premium of about 15% to the market price.

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Significant Tax Savings And Cost Synergies

There are some strong incentives for Pfizer to acquire AstraZeneca. Firstly, the acquisition would provide an opportunity for Pfizer to shift its headquarters to the U.K., thus resulting in a lower tax rate and significant savings which would boost its earnings. A 6 to 7% reduction in its tax rate could potentially help Pfizer save up to $1 billion. Additionally, the company can harness meaningful cost synergies by eliminating overlapping functions, thus increasing its margins in the near term.

Given its track record of making major acquisitions, we do not expect Pfizer to give up easily on AstraZeneca. Blackrock, which is the largest investor in AstraZeneca and second largest in Pfizer, wants the former to restart the negotiations as soon as possible. We expect that other major shareholders are likely to pressure the companies to reach a middle ground, especially given that the negotiations ended with less than a 10% difference in Pfizer’s final bid and the price that AstraZeneca was willing to consider.

AstraZeneca  Would Strengthen Pfizer’s Pipeline

Pfizer’s revenues have declined from $67.8 billion in 2010 to $51.6 billion in 2013 due to the loss of patent exclusivity of some major drugs, including Lipitor. Last quarter’s results were disappointing as well, due to the continued impact of generic competition as well as the expiration of certain co-promotion agreements for drugs such as Enbrel. Pfizer had pinned its hopes on some recent drug launches, but the market adoption has been rather slow. For example, its kidney cancer treatment drug Inlyta and lung cancer treatment drug Xalkori have seen weak sales over the last three years. Additionally, its rheumatoid arthritis drug Xeljanz and blood thinning medicine Eliquis have not performed as well as many expected. However, AstraZeneca’s pipeline could potentially fill in this gap.

Bullish about its oncology pipeline, AstraZeneca’s management is targeting a growth of 75% in its revenues by 2023. [1] It recently presented promising clinical trials data on two of its experimental drugs for the treatment of lung cancer. The peak sales for each of these drugs have been estimated to be between $3 billion and $6.5 billion. [2] Overall, the company expects to launch 10 new drugs in the next seven years.

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Pfizer Gets Drug Approval For Hot Flashes, Targets 33 Million Women In The U.S.

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The FDA recently granted approval for Pfizer’s (NYSE:PFE) Duavee, which has been developed by its wholly-owned subsidiary Wyeth in collaboration with Ligand Pharmaceuticals Inc. [1] The drug introduces a novel approach to treating hot flashes in menopausal women, and is also approved for the treatment of postmenopausal osteoporosis (common bone disease due to low estrogen levels). Unlike other drugs in the market, Duavee pairs conjugated estrogen (CE) with an estrogen agonist/antagonist (also known as a selective estrogen receptor modulator). The drug has the advantage of protecting uterus lining against hyperplasia, which increases risk of cancer of uterine lining and can happen with estrogen-only treatments. [1]

Given the reduction in cancer risk, we expect the drug to gain traction. There are approximately 33 million women in the U.S. between the ages of 45-59 (menopausal), and most of them experience hot flashes. [1] The quality of life can get significantly affected if this common condition is left untreated. Pfizer’s existing drug Premarin, which primarily consists of conjugated estrogen, earned over $1 billion in revenues in 2012. We expect Duavee to cannibalize some of Premarin’s sales starting from the first quarter of 2014. Furthermore, given that Pfizer is a well diversified company with several other major drugs, Duavee’s success will lead to only a small incremental value add.

Notes:
  1. How AstraZeneca escaped Pfizer’s clutches this time, Reuters, May 27 2014 []
  2. AstraZeneca shares fall after Pfizer walks away from deal, The Guardian, May 27 2014 []