Tuesday, January 27, 2009

Pfizer/Wyeth Merger Arbitrage Opportunity

Yesterday, the big news that moved markets was Pfizer’s 68 billion dollar acquisition of rival Wyeth. Pfizer will pay $33 in cash plus 0.985 shares of Pfizer stocks for each share of Wyeth. At Monday Wyeth closed at $43.39, which is 10.30% lower than the combination of Pfizer stock and cash, at the current price for Pfizer at $15.65.

Warren Buffett had a nice discussion on his arbitrage experience with Arcata Corp in the 1980’s in his 1988 letter to Berkshire Hathaway shareholders.

To evaluate arbitrage situations you must answer four questions:

(1) How likely is it that the promised event will indeed occur?
(2) How long will your money be tied up?
(3) What chance is there that something still better will transpire - a competing takeover bid, for example?
(4) What will happen if the event does not take place because of anti-trust action, financing glitches, etc.?

1. The next step in the process is that Pfizer will file with the SEC a Registration Statement on Form S-4 that will include a proxy statement of Wyeth that also constitutes a prospectus of Pfizer. Wyeth will mail the proxy statement/prospectus to its stockholders. The transaction is subject to the approval of Wyeth shareholders, and other customary closing conditions. The deal is likely to be reviewed by the Federal Trade Commission, which typically handles pharmaceutical acquisitions.

The transaction will be financed through a combination of cash, debt and stock. A consortium of banks has provided commitments for a total of $22.5 billion in debt, $22.5 billion in cash and 23 billion in equity. The deal is being financed by five banks: Bank of America Merrill Lynch, Barclays, Citigroup, Goldman Sachs and J.P. Morgan Chase.

2. Pfizer and Wyeth expect the transaction to close at the end of the third quarter or during the fourth quarter 2009.

3. Given the size of the deal it is unlikely that another suitor will come after Wyeth. One potential suitor that comes to mind could be Novartis (NVS). which will experience a similar problem just like Pfizer between 2011 and 2012, as several prominent drugs such as Diovan, Zometa,Femara, Lescol and Exelon which accounted for over one fifth of the pharmaceutical company’s 2007 sales will face US patent expirations.

4. The proposed transaction is subject to customary closing conditions, including approval by the stockholders of Wyeth, notification and clearance under certain antitrust statutes. In addition, the proposed transaction is subject to Pfizer's financing sources not declining to provide the financing due to a material adverse change with respect to Pfizer or Pfizer failing to maintain credit ratings of A2/A long-term stable/stable and A1/P1 short term affirmed. There are
no other financing conditions to closing in the merger agreement. Pfizer is financing the $22.50 billion debt with a jumbo one-year bridge loan and almost all the cash on its balance sheet.
After one year however, that bridge loan will come due and will have to be traded in for permanent financing, which could be jeopardized if the credit crunch hasn’t loosened by then.
After the deal was announced Fitch Ratings downgraded Pfizer's credit rating to 'AA' from 'AA+,' and placed the company's ratings on a negative watch. Moody's Investors Service and Standard & Poor's are reviewing their ratings on the acquirer. In the Pfizer loan agreement for the takeover, the banks can step back if Pfizer’s credit rating falls five notches below AAA to A or A2. If Pfizer’s credit rating falls enough for the banks to decline to finance the deal, Wyeth could potentially walk away with $4.5 billion.

In a document filed with the SEC there were several reasons why the deal might not go through
“There is the possibility that the merger does not close, including, but not limited to, due to the failure to satisfy the closing conditions; Pfizer's and Wyeth's ability to accurately predict future market conditions; dependence on the effectiveness of Pfizer's and Wyeth's patents and other protections for innovative products; the risk of new and changing regulation and health policies in the U.S. and internationally and the exposure to litigation and/or regulatory actions. the ability to obtain governmental and self-regulatory organization approvals of the merger on the proposed terms and schedule; the failure of Wyeth stockholders to approve the merger”

This would be an interesting deal to watch. Wyeth is trading at $43.39, Pfizer at $15.65, and the value of each WYE share if tendered by PFE today is $48.41. In the event that the deal closes as planned by late 3Q or early 4Q 2009, arbitrageurs could make as much as 11.50%.

For updates on the merger, check out this page.

Relevant Articles:

- Pfizer’s deal with Wyeth could be a blessing for shareholders, not as good for long term growth.
- Is Pfizer (PFE) a value trap for investors?
- Dividend Aristocrats in danger
- Constellation Energy (CEG) Merger Arbitrage Opportunity.

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