Under most circumstances, the opportunity for a pharmaceutical company to bolster its drug pipeline and slash its tax bill would be viewed by investors as a win.
But Salix Pharmaceuticals’ (NASDAQ:SLXP) announcement of a stock deal that would result reincorporate the gastrointestinal drug specialist in Ireland has gotten a cool reception from investors. Raleigh-based Salix’s stock price dropped by more than 5 percent Wednesday following the Tuesday night announcement of plans for a merger with a subsidiary of Italian company Cosmo Pharmaceuticals. Salix stock traded between $129.12 and $134 per share Wednesday.
Salix isn’t merging with Cosmo. Rather, Salix Pharmaceuticals Ltd. is merging with a Cosmo unit that’s based in Ireland, Cosmo Tech. The new company will carry be called Salix Pharmaceuticals Plc. Salix shareholders will own about 80 percent of this new Salix; Cosmo Pharma will own the remaining 20 percent. Besides the reincorporation, Salix also gets rights to drug candidates in Cosmo’s pipeline.
Investment firm Sterne Agee calculates the deal means that Salix is paying $1.74 billion for the Cosmo assets. That’s 20 percent of the 63 million outstanding Salix shares at Tuesday’s $137.27 closing price. Sterne Agee analyst Shibani Malhotra said in a report Wednesday that the reduction in Salix’s tax rate alone could be worth the entire amount the company paid in the deal. The company’s tax rate will go from 35 percent to the low 20 percent range in Ireland.
While the new Salix will be incorporated in Ireland, it will remain headquartered in Raleigh. Salix’s existing management team will stay in place, as will the board of directors, which will add one representative from Cosmo. Salix won’t be adding any U.S. employees though it plans to add some in Ireland.
If investors are fretting, it could be because Salix shareholders will be on the hook for taxes they weren’t expecting to pay. The company notes in its securities filings that the conversion of one share of Salix stock into one share of Salix plc stock is considered a taxable event, meaning all Salix shareholders will owe taxes when the deal closes even if they don’t sell their shares. The merger plan quickly sparked law firms to investigate whether Salix breached its fiduciary duty shareholders. Some firms are investigating whether Salix failed to maximize shareholder value by not getting more from Cosmo from the deal. Others are investigating whether Salix failed to consider alternatives, such as remaining independent or considering other buyers.
While shareholders may be left shouldering an unexpected tax hit, pharma and medical device companies are increasingly casting about overseas for M&A deals that would allow them to reincorporate in a lower-tax country, a move that’s called a “tax inversion.” Pfizer’s (NYSE:PFE) bid to acquire AstraZeneca (NYSE:AZN) was driven largely by such tax considerations, though AstraZeneca ultimately rejected its suitor’s offer. But Minnesota-based medical device giant Medtronic (NYSE:MDT) was successful, reaching a $43 billion deal last month to buy Ireland-based Covidien.
Salix executives talked up the deal as a good one for shareholders. The lower tax rate, CEO Carolyn Logan said on a conference call to discuss the deal, better positions Salix for future M&A deals, which will increase the value of the company.
Salix and Cosmo are no strangers to each other. Like Salix, Cosmo also develops gastrointestinal treatments. Cosmo also makes Uceris, the ulcerative colitis that became a Salix product when Salix’s acquisition of California pharma Santarus closed earlier this year. Santarus had licensed Uceris from Cosmo and owed milestone and royalty payments for the drug, payments that transferred to Salix. Another benefit to Salix’s deal with Cosmo is that Salix will no longer owe those payments after the deal closes. Cosmo will continue to supply the drug to Salix.
New products for Salix pipeline
The Cosmo deal also brings to Salix three product candidates developed around Cosmo’s proprietary MMX technology. Salix gains Cosmo’s U.S. patents for its drugs rifamycin MMX and methylene blue MMX. Rifamycin MMX is in phase 3 clinical trials for the treatment of traveler’s diarrhea and has projected peak year sales of $130 million. The drug candidate is also in phase 2 clinical trials for the treatment of diverticulitis, a condition in which small pouches in the inner lining of the intestine become inflamed or infected. Rifamycin MMX has projected peak year sales of $500 million for this indication. Methylene blue MMX is in phase 3 trials for colon cancer detection and has projected peak year sales of $500 million.
Salix will also have the right of first negotiation for gastrointestinal products that Cosmo seek to develop or commercialize in the United States. That gives Cosmo a ready commercialization partner who is already well established in the U.S. GI space.
The boards of directors for both companies have already approved the merger. The deal is still subject to approval from Salix shareholders and also must pass muster with U.S. regulators. The companies expect to close the deal in the fourth quarter.