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Why Pfizer Will Become Even More Compelling

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This article is more than 8 years old.

Despite its global presence, Pfizer (PFE) remains significantly underpriced, analysts point out, but before long its stock should become even more undervalued as its assets are bound to expand in value and reach, with its determined bid to acquire Allergan (AGN), the Ireland-based maker of Botox.

So investors who do not yet own shares in one of the world’s largest pharmaceutical companies should take advantage of Pfizer’s recent pullback, to $32 a share, off from its 52-week high of $36.46 -- and load up on the stock.

The new upward thrust in the stock should come from the projected combination of Pfizer and Allergan, which is headquartered in Ireland where corporate tax rates are way below those in the U.S. Allergan reported a tax rate last year of 4.8% vs. Pfizer’s 26.5% tax rate in the U.S. When combined, the two companies are expected to post total annual sales of about $53 billion.Skeptics argue that Pfizer will be overpaying for Allergan with its offer of $363.63 a share, or $160 billion. Allergan's stock surged some 6%, to $304 a share, on Oct. 29, when Pfizer and Allergan confirmed that they were in serious talks to do a deal.The potential merger appears to be a truly winsome prize for Pfizer, whose growth has been largely driven by acquisitions of several major drug makers, including Pharmacia in 2003 and Wyeth in 2009.

This new deal suggests a clear upside in valuation for Pfizer, according to estimates by analysts who describe the deal as “positive” for both companies. Combined, the two companies, they figure, represent a pro forma 30% upside for Pfizer’s stock.

“Our current Pfizer valuation remains at $41 a share, based on the weighted average of discounted cash flow, price-earnings multipled sum-of-the-parts ($44) valuations,” says Alex Arfael, analyst at BMO Capital Markets. He sees the combined companies increasing revenues by a compounded annual growth rate of about 3%, and per-share earnings by about 14% in 2017 to 2020.

On its own steam, Pfizer is showing “solid operational performance in 2015, and the core growth drivers of its innovative segment have very strong momentum heading into 2016,” says Arfael. He doesn’t think Pfizer’s offer for Allergan is excessive.

“Overall, we believe the price for the Allergan deal is fair and that it meaningfully improves Pfizer’s growth prospects and creates new opportunities to create value for Pfizer shareholders,” says the analyst, who rates the stock as “outperform,” with a price target of $41 a share.

Applying a “conservative 15-16 times to our 2017-2020 pro forma estimates, and discounting back accordingly, we arrive at a valuation of $41 a share for Pfizer +Allergan, (a 30% upside with the dividend),” says Arfael.

Jeffrey Loo, analyst at S&P Capital IQ, figures Allergan will benefit from Pfizer’s more extensive global growth, while Pfizer‘s growth will benefit from Allergan’s faster growing areas of aesthetics, dermatology, and eye care. “We think the Allergan deal was inevitable, given Pfizer’s desire for a tax inversion,” notes Loo.

The deal, expected to close in the latter half of 2016 – subject regulatory approvals – will combine the businesses under Allergan and keep Allergan’s domicile in Ireland for legal and tax reasons. But immediately after deal’s closing, the company will adopt the Pfizer name. Pfizer expects its tax rate to fall 17%-18% from 25% and expects synergies of about $2 billion over three years.

There is the question of whether the U.S. government will oppose a Pfizer-Allergan merger on grounds that it sees the notion of corporate inversions as a way to move outside the U.S. primarily to seek reduced tax rates. However, there is a growing consensus on Wall Street that government regulators won’t be able to stop the proposed merger.

“Our initial impression of the U.S. Treasury’s additional actions last week is that it is unlikely to be able to stop this deal,” says Arfael of BMO Capital Markets. He also sees Congressional action on the issue as a “low probability event in the current political environment.”

One likely positive twist in the projected merger that’s little discussed is the possibility that the deal could facilitate splitting Pfizer into two companies, which some estimate could be worth about $48 a share on a sum-of-the-parts valuation basis.

“We continue to believe that Pfizer is setting up a value-unlocking split in 2019, says Arfael. The potential split, he figures, “could unlock about 20% in value.”