The Pfizer-Wyeth Deal: Experimenting with Taxpayer Dollars?

On Friday, in an effort to ward off accusations of using bailout funds to finance the $68 billion Pfizer (PFE) acquisition of Wyeth (WYE), a Citigroup spokesperson said that, since the lending consortium plans to sell down the loan to pension funds and money managers, "no TARP funds will be in play at any stage of the deal." However, given the deal's structure, there is no way to reasonably ascertain how much of the $22.5 billion one-year bridge loan will appeal to secondary participants by the time the transaction is ready for closing.

The consortium includes Citigroup (C), Bank of America (BAC), Goldman Sachs (GS) and JPMorgan Chase (JPM) - all potential rescue targets in the forthcoming Bad Bank package. And there are concerns that adverse market conditions at closing, expected in the second half of this year, may force lenders to carry the Pfizer acquisition facility on their own books, amounting to a use of taxpayer dollars to fund a transaction whose immediate or near-term value-creation potential remains in doubt anyway.

At first glance, the yield (7-9%) for a superior credit ("AAA") like Pfizer appears to take into account a rapidly deteriorating economic environment. However, anybody pricing the bridge loan from the original syndicate will have to consider the potential downgrade of Pfizer's credit rating, the chaotic nature of the rating-to-yield debt matrix in the foreseeable future and the lack of liquidity implicit on the purchase of a bridge-loan arrangement. In brief, while the bailout candidates will certainly be able to place the loan in the huge secondary market, there is no basis to assume that the placement exercise will be profitable or tidy.

More importantly, placement or otherwise, lawmakers and regulators need to ask themselves two very obvious questions:

1. Could Wall Street banks have been in a position to provide Pfizer with a $22.5 billion commitment if they were not being propped up by taxpayer dollars?
2. Is government backup encouraging an acquisition, which will actually result in the shedding of jobs?

Pfizer publicly acknowledges that the combined company will shed 19,500 jobs. Pfizer has a 160-year history of terminating employee contracts, closing labs and shutting down production units after buying out smaller rivals, often without the creation of identifiable shareholder value. The Wyeth acquisition, health-care analysts suggest, is driven more by the eventuality that 38.5% of Pfizer's 2007 sales will face generic competition by 2013, as an increasing number of patents expire. Yesterday, a merger-arbitrage specialist stated:

With the real prospects of higher debt levels, of dividends being cut in half, and of revenues of the combined company declining by 17%, this is not a deal which has any meaningful inherent value at this juncture. Moreover, the Pfizer-Wyeth deal is showing a 12% arbitrage return, a telling sign that the chances of the deal not going through are surprisingly high.

That 12% return may be partly due to the fact that many of Wall Street's significant merger-arbitrage specialists are no longer active. But, that said, besides merger arbitrage, the $22.5 billion commitment provided by Citi, BofA, Goldman and JP Morgan has set in motion a chain of events, whose consequences for the debt-underwriting marketplace are highly uncertain.

1. Standard & Poor's has put Pfizer on negative watch.
2. Wyeth stands to collect a whopping $4.5 billion in break-up fees, a recent record, if Pfizer's ratings are cut and the banks don't lend.
3. If the yield on the bridge loan becomes a standard benchmark, junior credits can expect to pay no less than 12-15% on mezzanine funds—so much for credit flowing through the system at low interest rates.
4. In their quest to gain fee income (total estimated to be $210 million), banks are willing to commit M&A funds at rates which are below those being paid on preferred instruments issued to the government.

Once again, the argument being presented to the street by syndicate members is that they will finally end up holding only a limited portion of the Pfizer transaction, if at all, on their own books, and that the $22.5 billion commitment should be viewed more as an underwriting facility than a direct loan. But this type of bet on the shape of the future makes sense only when "stand-alone" balance sheets justify the assumption of the associated risks, not when a $2 trillion Bad Bank law is currently in the works. In fact, the entire business of underwriting must now be conditioned by rigid capital adequacy ratios on one hand and by measurable pricing methodologies for both debt and equity, on the other. Otherwise, history will repeat itself: lucrative fee-income considerations will trump prudence and technical integrity.

Disclosure: Short Pfizer is a merger-arbitrage trade, against long Wyeth. Author short BAC, GS and JPM.

Comments

[Tom B]

The Government should step in and prosecute the bankers for fraud. The TARP was supposed to rescue the economy by preventing bank failure; not to finance deals that so clearly in opposition to the public good. If the deal goes through, ten of thousands will lose their jobs, and every America will see a delay in obtaining new, life-saving medicines, because their will be fewer people to invent them. In what year of B-school do they yank these peoples brains out, or are they that way going in?

2009 Feb 02 10:54 AM

[Jason Rines (iThinkBig)]

Don't be on the wrong side of the trade. Realize government is acting fascist. You can either be on the right side of the trade, profit and put a portion of those proceeds to help restructure our country or you can continue be shaken upside down. I am as red blooded Patriot as they come but realize you don't win victories until you start playing your enemies game and utilize it against them.

2009 Feb 02 11:21 AM

[rd4sndk]

Its this type of blog that's driving me crazy. Do you expect Pfizer to welch on its loans or that the expected $20B in CF to not materialize? How obsurb is to restrict the banks from loaning to a bluechip company with $20B+ in cash reserves and a FCF greater than $10B. Find something else to do with your time and leave us alone with absurb fears of Pfizer failures. I for one welcome such transactions and plan to take part in the arbitrage shortfall to reap my 12% in 90 days.

There are transactions that unhealthy banks have made and I didn't hear you questioning those like Citi's planned purchase of Wachovia etc. Now there's a merger that was rightfully terminated.

2009 Feb 02 11:25 AM

[Rakesh Saxena]

Dear rd4sndk: You are missing the point completely; please re-read the post. What is in question is the underwriting-type risks the banks when it is not clear if their balance sheets support those risks. Particularly in the face of an impending Bad Bank package. Nobody is questioning Pfizer's ability to close or re-finance. Many thanks - Rakesh


On Feb 02 11:25 AM rd4sndk wrote:

> Its this type of blog that's driving me crazy. Do you expect Pfizer
> to welch on its loans or that the expected $20B in CF to not materialize?
> How obsurb is to restrict the banks from loaning to a bluechip company
> with $20B+ in cash reserves and a FCF greater than $10B. Find something
> else to do with your time and leave us alone with absurb fears of
> Pfizer failures. I for one welcome such transactions and plan to
> take part in the arbitrage shortfall to reap my 12% in 90 days.
>
>
> There are transactions that unhealthy banks have made and I didn't
> hear you questioning those like Citi's planned purchase of Wachovia
> etc. Now there's a merger that was rightfully terminated.

2009 Feb 02 12:17 PM

[Rakesh Saxena]

typo correction "what is in question is the underwriting-type risks the banks are assuming when....."


On Feb 02 12:17 PM Rakesh Saxena wrote:

> Dear rd4sndk: You are missing the point completely; please re-read
> the post. What is in question is the underwriting-type risks the
> banks when it is not clear if their balance sheets support those
> risks. Particularly in the face of an impending Bad Bank package.
> Nobody is questioning Pfizer's ability to close or re-finance. Many
> thanks - Rakesh

2009 Feb 02 12:19 PM

[pfeskeptic]

Question: Does Pfizer's announced $2.3 billion settlement with the U.S. Attorney (to end an investigation of illegal marketing practices associated with Bextra) increase the company's financing needs for this acquisition? Does an absence of this cash due to the settlement require the company to borrow more and would this, in any way, consume capital that TARP recipient banks could be using for other purposes that do not kill jobs?

I honestly do not know the answer to this question, but those who are concerned about the TARP connection to this deal (if there is, in fact, a connection) might also take issue with the financial impact of Pfizer's settlement.

Anyone have anything intelligent to say about this? Thanks

2009 Feb 02 09:22 PM

[Rakesh Saxena]

Dear pfeskeptic. I was told by a long-term health care analyst that Pfizer was expecting this settlement, with or without the Wyeth deal. On the other hand, the $2.3 billion could have been used to reduce the syndication amount from the bailout candidates, so there is that TARP connection. More importantly, it is important to note that without government backup, the syndication could not have underwritten the Pfizer loan in the first place. Many thanks - Rakesh


On Feb 02 09:22 PM pfeskeptic wrote:

> Question: Does Pfizer's announced $2.3 billion settlement with the
> U.S. Attorney (to end an investigation of illegal marketing practices
> associated with Bextra) increase the company's financing needs for
> this acquisition? Does an absence of this cash due to the settlement
> require the company to borrow more and would this, in any way, consume
> capital that TARP recipient banks could be using for other purposes
> that do not kill jobs?
>
> I honestly do not know the answer to this question, but those who
> are concerned about the TARP connection to this deal (if there is,
> in fact, a connection) might also take issue with the financial impact
> of Pfizer's settlement.
>
> Anyone have anything intelligent to say about this? Thanks

2009 Feb 03 12:46 AM

[buyitcheap]

Wouldn't short Wyeth be a better idea if the deal falls apart?

2009 Feb 03 07:32 AM

[macsmart]

Isn't the idea that we want banks to start lending again to get business moving again?

2009 Feb 03 09:34 AM

[Rakesh Saxena]

Dear buyitcheap: The short or long position depends on the merger-arbitrage spread. The question of which stock will suffer if the deals fails is still an open question which I am checking with healthcare analysists. Will provide updates shortly. Many thanks - Rakesh


On Feb 03 07:32 AM buyitcheap wrote:

> Wouldn't short Wyeth be a better idea if the deal falls apart?

2009 Feb 03 11:12 AM

[Rakesh Saxena]

Correct macsmart. The issue really is "what type of lending?" This deal is not a "money flowing through the system" deal, and is contrary to what we hear from Washington. But, then again, nobody in Washington is objecting to the deal!!! -Many thanks - Rakesh


On Feb 03 09:34 AM macsmart wrote:

> Isn't the idea that we want banks to start lending again to get business
> moving again?

2009 Feb 03 11:14 AM

[Rakesh Saxena]

Dear juan77: At this point, from available data, it appears that PFE will need to raise about $35 billion by the 12th month after the deal is completed; this number could vary according to PFE's performance over the next six quarters. Whether PFE decides to issue new shares to refinance the S/T loans is an open question, to be influence by market conditions. But, yes, you are right in recognizing the dilution risk. Many thanks - R


On Feb 04 02:15 PM juan77 wrote:

> Other than the bridge loan, how much capital does PFE need for the
> acquisition?
> If it has to raise capital by issuing new shares, will PFE's stock
> price suffer the same fate as BAC and WFC which raised additional
> capital by issuing stock at a discount to market value?
> n which case, is PFE a viable short candidate?

2009 Feb 04 10:46 PM