Pfizer failed in its takeover bid for AstraZeneca because of overconfidence

http://www.theguardian.com/business/2014/may/19/pfizer-failed-takeover-bid-astrazeneca

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Beyond the political huffing and puffing, the debate about what Pfizer would have to pay to bag AstraZeneca always seemed straightforward: a bid of £60 a share or thereabouts would be a knockout; anything less and Pfizer would struggle to get an agreement.

So it has proved. Pfizer proposed £53.50 at the weekend but was told by AstraZeneca to add 10% – taking the offer to £58.85 – to get in the game. The US group then angrily tabled £55 as a take-it-or-leave-it "final" proposal and implored AstraZeneca's shareholders to rise up in rebellion against their recalcitrant directors.

The mutiny, such as it is, looks feeble. Fund managers at Axa and Jupiter may be "disappointed" by the stance taken by AstraZeneca's board but that hardly amounts to a thunderous call for resignations. As AstraZeneca's chairman, Leif Johansson, pointed out, independent directors are paid to give their opinion. If shareholders don't like that opinion, their only real remedy is to appoint different directors.

While Axa & co sulk, the rest of the world should applaud Johansson and colleagues for taking a clear decision on what's best for their company and displaying coolness under fire. Few company boards manage to behave so robustly. It is now almost impossible to see how AstraZeneca's board could change its mind about a £55 bid and keep its credibility – at least, not before next Monday's deadline imposed by the Takeover Panel. And, since Pfizer cannot now bid more than £55 under the panel's rules, this scrap looks to be virtually over.

There is no precise science to why £60-ish would have been the "right" price. It's just that all bid battles acquire momentum and a sense of where the winning line lies. Pfizer started poorly. Few regarded its opening pitch of £50 as anything other than a sighting-shot. Worse, the offer quickly became worth only £48 because Pfizer's share price fell 6%, reducing the value of the paper part of its cash-and-shares proposal.

Pfizer's weak share price betrayed some nervousness among its own shareholders about the adventure – hardly surprising given that its chairman and chief executive, Ian Read, had previously said he had given up on big deals. Critically, it also reduced the bidder's firepower when the bidding became serious. Pfizer was offering an unreliable currency, and its past takeovers – Warner Lambert, Pharmacia and Wyeth – did not inspire confidence that the best way to pursue value was yet another round of cost-cutting. The bar for a successful share-based offer was always going to be set high; and raising the cash component to 45% from 33% was only a marginal improvement.

On the defending side, Pascal Soriot did what all defending chief executives must do and painted a happy picture of life as an independent company. He argued that AstraZeneca investors had not appreciated the possible wonders in store in the group's pipeline of potential drugs, especially the cancer portfolio. His forecast that revenues could improve 75% by 2023 employed optimism, but not in heroic doses.

One bank, Citi, declared AstraZeneca's "intrinsic value" to be £49 a share. Add a 20% takeover premium to that number and you've got the £58.85 figure at which AstraZeneca drew a line in the sand.

In short, Read miscalculated what he would have to pay. Some would call it an understandable mistake since £55 is quite a jump from AstraZeneca's share price before news of Pfizer's interest – £39. Offers at a 45% premium usually succeed and AstraZeneca itself also had a long record of broken promises under Soriot's predecessor, David Brennan.

But Read's naked aggression was counter-productive. "Pfizer's approach throughout its pursuit of AstraZeneca appears to have been fundamentally driven by the corporate financial benefits to its shareholders of cost savings and tax minimisation," said Johansson. Fair comment.

Pfizer never attempted to address AstraZeneca's worry that valuable research projects would be binned if the company was carved up to fit the US group's operating model.

Nor did Pfizer ever go public with the size of the cost and tax savings. Would the plan to flip Pfizer's tax domicile to the UK have yielded $1bn a year or $2bn? Read, one assumes, did not want to risk a greater political backlash in the US by going into detail about the tax wheeze. But it's hard to inspire a rebellion in AstraZeneca's ranks if you don't tell investors the size of the prize they are meant to be chasing. Pfizer looked suspiciously defensive on the tax point.

What happens next if, as expected, Pfizer is obliged to walk away? A bidder can return in six months' time and the US group now knows, roughly, the price it would have to pay. But £70bn-plus deals tend to require many stars to align.

A lot can happen in half a year. The US might ban tax inversions, or make them harder to implement. Pfizer's share price might fall, or AstraZeneca's might rise on the back of good results for drugs in late-stage clinical trials.

Read's position might also come under pressure. He raised a small army of investment bankers and created a political storm on both sides of the Atlantic, but has nothing to show for his efforts despite starting as a heavy favourite. That can be career-threatening.

Of course, events could go in the opposite direction. Having appealed for long-term support, AstraZeneca now has to deliver in an industry where 100% guarantees do not exist. The company has a lung cancer treatment deemed capable of generating revenues of $6.5bn (£3.9bn) a year. If that were to fail in late-stage trials, AstraZeneca would be vulnerable once again. Soriot probably has about 18 months to get the share price close to £50 under his own steam, which would vindicate the decision to reject £55.

As for British politicians, they must now decide whether a wider public interest test would be useful. All the well-aired arguments about protecting the science base, versus protecting the UK's open-doors policy on takeovers, still apply. But the story of the bid battle itself is very simple: Pfizer was over-confident and never offered enough to win. Well played, AstraZeneca's directors.