Allergan Implodes: Pfizer Deal In Jeopardy After Treasury Announces "Action To Curb Inversions, Earnings Stripping"

As if a million M&A arbs suddenly cried out in terror, and were suddenly silenced.


Moments ago the stock of Allergan imploded, crashing by 20%, plunging to $225 or the lowest level since late 2014, in the process blowing up countless M&A arb deals which were hoping the recently blowing out spread, which as of Friday hit a post announcement wide of $61, is attractive enough to take the risk of a Treasury crackdown on tax inversion deal.

Alternatively, maybe someone knew something.

Something, such as what the Treasury announced 5pm this afternoon in a release titled "Treasury Announces Additional Action to Curb Inversions, Address Earnings Stripping"

As the title implies, the Treasury has just made it quite clear that any and all tax inversions, of which the Pfizer-Allergan deal is most notable, are no longer welcome. This is what it said.

Treasury Announces Additional Action to Curb Inversions, Address Earnings Stripping


Today, the U.S. Department of the Treasury and the Internal Revenue Service (IRS) issued temporary and proposed regulations to further reduce the benefits of and limit the number of corporate tax inversions, including by addressing earnings stripping. By undertaking an inversion transaction, companies move their tax residence overseas to avoid U.S. taxes without making significant changes in their business operations. After an inversion, many of these companies continue to take advantage of the benefits of being based in the United States, while shifting a greater tax burden to other businesses and American families.


Treasury has taken action twice to make it harder for companies to invert. These actions took away some of the economic benefits of inverting and helped slow the pace of these transactions, but we know companies will continue to seek new and creative ways to relocate their tax residence to avoid paying taxes here at home,” said Treasury Secretary Jacob J. Lew. “Today, we are announcing additional actions to further rein in inversions and reduce the ability of companies to avoid taxes through earnings stripping. This will have an important effect, but we cannot stop these transactions without new legislation. I urge Congress to move forward with anti-inversion legislation this year. Ultimately, the best way to address inversions is to reform our business tax system, which is why Treasury is releasing an updated framework on business tax reform, outlining the administration’s proposals to date as a guide for future reform. While that work goes on, Congress should not wait to act as inversions continue to erode our tax base.”


Genuine cross-border mergers make the U.S. economy stronger by enabling U.S. companies to invest overseas and encouraging foreign investment to flow into the United States. But these transactions should be driven by genuine business strategies and economic efficiencies, not a desire to shift the tax residence of a parent entity to a low-tax jurisdiction simply to avoid U.S. taxes.


Today, Treasury is taking action to:

  • Limit inversions by disregarding foreign parent stock attributable to recent inversions or acquisitions of U.S. companies. This will prevent a foreign company (including a recent inverter) that acquires multiple American companies in stock-based transactions from using the resulting increase in size to avoid the current inversion thresholds for a subsequent U.S. acquisition.
  • Address earnings stripping by:
    • Targeting transactions that generate large interest deductions by simply increasing related-party debt without financing new investment in the United States.
    • Allowing the IRS on audit to divide debt instruments into part debt and part equity, rather than the current system that generally treats them as wholly one or the other.
    • Facilitating improved due diligence and compliance by requiring certain large corporations to do up-front due diligence and documentation with respect to the characterization of related-party financial instruments as debt.  If these requirements are not met, instruments will be treated as equity for tax purposes.
    • Formalize Treasury’s two previous actions in September 2014 and November 2015.

 Treasury will continue to explore additional ways to address inversions.
Treasury is also releasing an updated framework for business tax reform, which revises the framework released in 2012. This lays out the key elements of the President’s approach to reform and details the specific proposals the administration has put forward, including a comprehensive approach to reforming the international tax system.

The Allergan-Pfizer spread now is basically to levels as if the deal never happened:


We can't wait to find out how many M&A arbs, who had anywhere between 2x and 5x (or more) leverage on the arb spread (of which the most notable recent arb chaser is none other than Franklin resources whose Dec 31. $1.3BN pure arb stake is now worth 20% less in an instant) just blew up after hours with just this one simple press release.

The table below shows why Franklin Resources will be short one employee tomorrow:

We also wonder how this will impact the broader, and quite illiquid, market tomorrow.