AstraZeneca – Pfizer Bid

AstraZeneca – Pfizer’s bid raises questions over the future of giant pharmaceutical companies

The attempt by Pfizer to achieve the takeover of AstraZeneca with the recommendation of the board of its rival has captured the attention of all those with a direct interest in the result and many others besides.

This in-depth article by Nigel  analyses the saga and considers the lessons to be learned from the takeover attempt, examining it against our Five Golden Rules of corporate governance. Covered in the article is the following:

The way the game was played influenced the outcome

How we would approach the decision (the Golden Rules)

Our verdict

Issues at stake

Let’s consider the issues at stake here and let’s look at them under two broad headings

Industry’s strategic issues

The increased costs of technology and increasing regulation have been driving up the costs of developing new drugs in recent years. The answer for “big pharma” has been size, resulting in larger and larger companies which possess the scale and resources both to develop ground-breaking new products over the very long timescale needed to bring them to market, and the global reach to sell these new drugs to (mainly) governments on a world-wide basis.

Unfortunately, it is starting to seem as though these giant, industrialised research and development facilities are not necessarily the most effective way to create new drugs. It appears that the most productive environment may well lie in smaller academic or private laboratories, free of the systems and constraints imposed by large organisations.

The giant drug companies are also facing the perennial problem of the progressive expiry of the patents covering their most successful products. This “cliff edge” issue leaves them facing quite dramatic potential reductions in revenue. Hence they live with the hope that their new drugs under test will be both successful and approved in time to maintain the scale and infrastructure of the companies developing them. Otherwise their markets will be captured by producers of low-priced generic versions of these drugs.

The approach taken by the big companies has therefore been to rationalise dispersed research facilities and cut administration costs. However, once a company has done as much as it can to improve its own cost ratios, the next move has to be a merger so that the same process can be applied to the combined entity.

Regarding the growing perception that research is more successful in independent laboratories, the answer is to buy these facilities to acquire the new products they are developing.

Both these approaches have been adopted by Pfizer and AstraZeneca, and the combine to rationalise move is what has driven Pfizer to attempt this latest merger.

Incentive misalignments

The second set of issues relates to the so-called misalignment of personal incentives with the requirements of the industry. Both managers of the pharma businesses and fund managers who invest in them, are judged (and paid) by reference to quite short-term results, but the requirements of the business are for long-timescale thinking and deferred returns on the investment needed to produce the desired ground-breaking new products.

The UK Stewardship Code recognises the need for investors to engage more closely with the management of the companies in which they invest. However, it can’t solve the deep-seated disincentives which include both an unwillingness to spend valuable time getting involved with companies whose shares they may only hold for a short while and a more fundamental wariness of exposing themselves to what may be later interpreted as insider information.

The competing points of view

The interested parties in a clash of titans are many and varied. It is always to be hoped that in a battle for support like this, rational argument is the winner. However, let’s consider who has been making noise and who has been more restrained.

Who shouts loudest?

The battle for the ears of the public has been led by the board of the aspiring acquirer, Pfizer, and that of the target acquisition, AstraZeneca. Both have been civilised, if forceful, in their arguments and both have employed leading UK PR firms. Pfizer has stressed the efficiency arguments for combining the companies, while playing down the tax benefits. AstraZeneca has fundamentally disagreed with the strategy outlined for the combined company and stressed the problems of implementation while playing up the value of its pipeline of new products.

The shareholders in the target acquisition have made their views quite well-known, particularly as the Pfizer approach seemed to be failing and the divergence of views became more public. Those against have emphasized the future value in AstraZeneca’s pipeline and their negative perception of Pfizer’s approach and prospects. Those in favour have bemoaned the loss of the profit which would have accrued quickly and safely to them had the deal gone through, compared with the uncertainty of waiting for AstraZeneca’s promises to be fulfilled.

Then the politicians in both the UK and the US have taken quite high profile positions – the UK predictably about a rapacious foreign predator running off with a prize national asset and the US about big business wrongly keeping its tax out of the hands of the domestic revenue service. Finally, the UK media have had a range of good stories, from the populist support for the preservation of British science and British jobs, to the protection of the rights of shareholders to sell to whomsoever they wish without interference from the state.

Moderate shouters 

Moderately vocal has been the UK government, which initially was seen to be giving support to the merger but quickly backed off to a neutral position when attacked by the opposition.  Similarly, the US Congress has muttered about the use of “inversion” to enable large US companies to lower their US tax rate but no actions have yet been taken to tackle this, which might still threaten the merger if it is resurrected at a later date.

If Pfizer’s own shareholders have strong views about the merger, they haven’t been reported in the UK, so it has to be assumed that they support the board. The unions in the UK have reminded the public of Pfizer’s actions in closing a major UK research facility recently, with its impact on employment in the local community.

And academic scientists have warned about Pfizer’s apparently diminishing commitment to its own research capability, drawing lessons for the future of research in the combined business and, by extension, the national science base. Also, letters have been written drawing attention to the dangers faced by pension fund beneficiaries in this kind of merger.

Who hasn’t shouted at all 

One of the biggest stakeholders might be thought to be the customers of the two big pharma groups, but little has been heard from this quarter. The UK National Health Service is a major user of drugs but if it has concerns it hasn’t made much of a fuss about them. Finally, and most curious of all, the views of the competition authorities do not seem to have been much of a feature though their agreement would seem to be absolutely critical. The AstraZeneca board mentioned its concerns about the difficulties of getting approval from the Chinese authorities, but even more important would surely be those of the UK, US and EU.

Who can’t shout?

Finally, of course, at least in the UK, a company is treated as an independent entity from those who own the shares. And the Companies Act requires the directors to act to promote the long term success of the company, while taking into account the interests of employees, suppliers, customers and other key parties and also the wider community. Hence the long term successful future of the company should be at the heart of the debate. But who truly speaks for the company?

Dangers

In assessing which way the decision should go, downsides and dangers need to be considered. Let’s consider these under two main headings.

Strategic and operational

What are the possible flaws in the strategic views expressed by the two giants? Pfizer appears to want to break itself up, separating the established (and boring) drugs and those nearing the end of patent protection from the newer drugs and those (exciting) drugs in development. But first it wants to bulk up by merging with a large rival, presumably so that the ultimately separate companies are that much larger after separation.

Astra Zeneca disagrees and says that even in the unlikely event that the merger were to be approved the execution risks would be dangerously large. Who is right? Does the Pfizer view of the way ahead make sense? Does the future of big pharma lie in the creation of ever-larger companies or are these dinosaurs heading for extinction? The history of mega-mergers has enough recent examples of disasters, such as RBS and ABN Amro, to raise huge doubts about the practicalities of overcoming cultural differences and the practical problems of integration.

Is AstraZeneca’s independence important for the future development of its important new drugs? What is the real value of practically unenforceable guarantees regarding the location and size of future research facilities?

What hostages to fortune may be given by the different views of the valuation of AstraZeneca? In the eyes of the shareholders denied £55 per share in Pfizer’s “final offer” that is the minimum that management must achieve if it remains independent. By their own calculation, the board of AstraZeneca values the company even higher.

However, though they will be tested regarding their own estimates, if they retain independence, it will be completely unprovable whether the merged company could have performed well enough to justify the £55 price Pfizer was offering. Implementation could well have destroyed significant value instead, so that retaining independence might be beneficial even if the £55 value is not quite achieved.

Political

Politicians’ have their own agendas. National champions and protectionism can figure quite high on their list of priorities and if the merger were to be pursued it would surely be subject to attack from this quarter. Dealing with such an attack would certainly be distracting and concessions could very well jeopardise the success of the merged company. It would not be the first time that ideology had got in the way of common sense and commercial wellbeing.

Also, it is a good general rule that business decisions should be made with tax in mind rather than for tax reasons. Current tax policies in the UK and the US were a major factor in this approach. However, tax policies can change suddenly and dramatically and render invalid the original justification for the business decision. One has only to look at incentives offered for regional development to see the dangers here.

Just look at the inconsistency of the UK government offering tax incentives to entice international companies to invest in research in the UK while deploring other international companies such as Starbucks and Google for signing up to tax incentives in other countries and hence not paying sufficient tax in the UK. And the US will surely take action at some point to address the inversion route to reducing US corporate tax liabilities.

The way the game was played influenced the outcome

The cultural differences between the two companies during the negotiations probably anticipated likely problems post merger.

It seems that after the initial approach by Pfizer to AstraZeneca back in November 2013, detailed discussions were held in January 2014. Following these meetings the AstraZeneca board rejected an outline offer and Pfizer then told them it was not actively considering an offer. However, in April Pfizer renewed contact and reiterated its interest, to be told that nothing had changed.

After a leak to the press, Pfizer then went public with an indicative offer which was dismissed by the AstraZeneca board as undervaluing the company. Pfizer then raised its indicative offer and was rejected again with an indication of the price at which the AstraZeneca board would be prepared to reconsider. Having apparently told the AstraZeneca board that it would go no higher, Pfizer then publicly issued a final, higher offer, but lower than the indicated minimum, with a commitment not to go hostile. This too was rejected.

Having gone public in April with its expression of interest, Pfizer was then required by the UK Takeover Panel’s rules to “put up or shut up” within a month. The time pressure appears to have taken the Pfizer team into unfamiliar territory and since they were unwilling to risk a hostile bid, they had to resort to trying to put pressure on the UK company’s management.

As a result, both sides seem to have become irritated with each other’s attitudes, not helped by the influence of the PR firms’ efforts publicly and privately with politicians, the media and the Astra Zeneca investors. In the event, AstraZeneca’s advisers seem to have done the better job and won the PR battle.

So Pfizer ran out of time to persuade the opposing board to make a recommendation and have now withdrawn from the fray – at least for the time being.

How we would approach the decision

How would the application of our Five Golden Rules of good corporate governance guide the decision of the AstraZeneca board? The rules address the Ethics of the business, the degree of support for a common Goal among the key stakeholders, the existence of a valid Strategy to implement the goal and an Organisation resourced and structured to deliver it, and proper Accountability and transparency towards the stakeholders.

The key discussion would have to be around the degree of support by the major stakeholders regarding the Goal for the merged business and the validity of the Strategy to achieve it.

It seems very clear that the two boards disagreed fundamentally about the Goal of a giant merged business that would then be demerged. They also disagreed about the feasibility of the Strategy to implement this mooted goal. The main shareholders also disagreed, but here there were other differences. One group appeared to have little or no interest in the goal let alone any strategy, but was concerned solely with achieving the biggest exit price they could get. The other group expressed a preference and support for the independent future of AstraZeneca, coupling this with a confidence in the ability of the executive team to achieve business results which would ultimately justify a higher valuation.

The employees weren’t asked, but to the extent that their views came into the public domain, they were against losing independence, fearing job losses. No-one seems to have made much attempt to take the views of the customers, though the UK government (owner of the National Health Service) publicly sat on the fence. A key interested party, the Competition authorities, weren’t brought into the discussion, though they would ultimately have to rule on the merger.

Our verdict

Our verdict would have to be that the strong disagreement over the Goal for the combined business would put a big question mark over the chances of coming up with a feasible strategy to achieve it. Thus the organisational changes required would be highly problematic and likely to fail.

Overall, therefore, in considering the duty of the directors of AstraZeneca under the Companies Act to promote the future success of the business, taking into account the interests of employees and other key stakeholders, it should be an easy one for the board to turn down. Hence the long term interests of the company prevail over the short term interests of some shareholders.