PAC Pacific Current Group Ltd

Pfizer Inc. said Wednesday it would walk away from its planned $150 billion takeover of Allergan PLC, after the Obama administration took aim at the deal that would have moved the biggest drug company in the U.S. to Ireland to lower its taxes.

The Wall Street Journal reported Tuesday that Pfizer's board had voted to halt the combination and the New York-based pharmaceutical company then notified Dublin-based Allergan.

Pfizer will pay Allergan a breakup fee of $150 million.

The decision to walk away is the latest setback in Pfizer's long-running efforts to overcome what Chief Executive Ian Read has said was the company's competitive disadvantage with foreign rivals that faced significantly lower tax bills.

In 2014, Pfizer had tried but failed to buy British drugmaker AstraZeneca PLC. Afterward, it looked for a new partner, before finally reaching terms with Allergan.

By combining with Ireland-based Allergan, Pfizer could not only cut its tax rate but also get access to the billions of dollars in revenue it was keeping overseas to avoid paying U.S. taxes on top of the taxes it had already paid in foreign countries.

The combination also had nontax benefits for Pfizer, including access to Allergan's portfolio of strongly growing products like antiwrinkle treatment Botox, dry-eye treatment Restasis and new irritable-bowel drug Linzess.

A combination also might have paved the way for Pfizer to shed its collection of cash-generating but older slower-growth drugs.

Tax-inversion deals have become commonplace in U.S. corporate deal-making. They have also become a talking point in the U.S. presidential campaign, with certain candidates attacking the uprooting of American companies and departure of tax receipts.

The tie-up between Pfizer and Allergan, the biggest merger announced last year—the busiest ever for takeovers—was a particular campaign target. Republican and Democratic presidential candidates have criticized the deal.

President Barack Obama on Tuesday called corporate inversions, in which a U.S. company buys a foreign rival and adopts its lower-tax jurisdiction, one of the "most insidious tax loopholes out there." Companies that have inverted frequently make more acquisitions of U.S. companies to bring them on to their lower-tax platforms.

The problem, Mr. Obama said, isn't that companies are engaging in illegal activity, but what is legal in the first place.

The government had so far been unable to do much to stop corporate inversions, but that clearly changed with Monday's publication of a third installment of proposed rule changes, the stringency of which came as a surprise to many.

In an effort to crack down on what the Treasury Department calls "serial inverters," the new regulations would disregard three years' worth of U.S. acquisitions when determining a foreign company's size under the tax code.

That complicated the finely tuned math that was crucial for inversions like Pfizer's to work. To reap maximum benefits, shareholders of the inverting company should own between 50% and 60% of the combined entity. Between 60% and 80% also works, but the tax perks are diminished, and above 80%, they are lost entirely. So U.S. companies need inversion partners that are at least one-quarter their size, and ideally more like two-thirds.

When the Allergan deal was struck last year, Pfizer's market capitalization was about $200 billion and Allergan's was about $120 billion. Pfizer's shareholders would own 56% of the combined company.

But stripping out three years' worth of deals done by Allergan—which Treasury certainly would consider a serial inverter—that math no longer works. Allergan has 395 million shares outstanding.

It has issued about 260 million shares for big deals, including the $25 billion takeover of Forest Laboratories and the $66 billion combination of Actavis and Allergan last year.

Stripping those out leaves about 130 million shares, worth only about $30 billion. Under the current merger ratio, Allergan shareholders' stake in the combined company would likely drop into the high teens.

In other words, in the eyes of Treasury, Allergan would have been too small to be Pfizer's inversion partner.

Allergan shares fell 15% Tuesday, a sign that many investors considered the deal to be dead. Pfizer shares rose 2.1%.

The White House denied the new rules were targeted at a specific company.

"The Treasury Department is not focused on a specific transaction, it's focused on specific loopholes," White House press secretary Josh Earnest said. The White House declined to address the specific Pfizer and Allergan situation, but Mr. Earnest said the administration would be "pleased" if inversion deals fell through.

Write to Jonathan D. Rockoff at Jonathan.Rockoff@wsj.com, Liz Hoffman at liz.hoffman@wsj.com and Richard Rubin at richard.rubin@wsj.com

(END) Dow Jones Newswires

April 06, 2016 07:35 ET (11:35 GMT)

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