The underlying fund for the TAMIM Global Equity High Conviction IMA, managed by Robert Swift, has owned the global biopharmaceutical company Pfizer for a few years now, and as an investment it has been strong performer for the portfolio. It was originally an attractive investment due to the fact it was undervalued, but also for the following reasons:

• ​Strong pipeline of drugs albeit mature – Lipitor (cholesterol), Viagra and Celebrex (anti inflammatory). These drugs were heavily geared to an aging population which is the current situation in the USA, and also that of the rest of the world which buys them
• Acquisitions of Warner Lambert, Pharmacia and Wyeth in 2000’s all showed that the company could develop and buy growth. These acquisitions are getting harder (eg Astra Zeneca proposal was effectively blocked by UK politicians)
• No material problems with governance or accounting

​We are now at the point where we believe the risk/reward trade-off is no longer in our favour, and our proprietary VMQ  score while still favourable is not at the attractive levels it was when we first entered the position.

​Pfizer operates in a sector facing common challenges. All pharmaceutical companies have an increasingly higher research and development (R&D) spend in order to come up with the next blockbuster drug. But that means more and more capital is at risk with each drug investment: i.e. the capital intensity is rising and it strikes us that many drug companies are looking more and more like car companies where it costs so much to develop a new car platform, that a failed model can jeopardise the whole business. Generics are also coming to market faster which erodes periods of super profitability for the established companies; and recently a political threat is now posed by Bernie Sanders and Hillary Clinton where we perceive both would be happy to bash the large US pharmaceutical companies.

Pfizer is also about to do a tax inversion deal. As we wrote in late 2015 as we pondered our investment:
“It has been widely documented that a key rationale of the Pfizer-Allergan mega merger is tax minimisation. By re-domiciling the company in Ireland, Allergan’s home, Pfizer will have the ability to avoid US taxes on $128bn of profits earned outside the United States.” A tactic commonly referred to as ‘tax inversion’.

Exploitation of this tax ‘loophole’, while great for potentially increasing shareholder value in the short term (and is not a sustainable way of growing earnings), presents a dilemma for the US government which has the authority to block the transaction. If they allow it to happen will we see a further rush of companies looking to follow in Pfizer’s footsteps? Or, could this deal be the catalyst for legislators to review and overhaul US corporate tax policy, acknowledging that high corporate taxes on USA based companies are not the way to encourage inward business investment?

Pfizer is not alone. Many multi-nationals in the US and UK are fed up with high costs, capricious regulations, and relatively higher taxes. It is not surprising that Pfizer are trying to minimise corporation tax since they already incur higher costs of doing business in the US including the funding of expensive healthcare and pension plans. Currently HSBC is ‘running the numbers’ on whether it should relocate to Hong Kong.

We are troubled by this deal not because of the tax benefits, but because it appears to be the only reason to do the deal. Corporate finance 101 taught us that the underlying purpose of a merger was to achieve a result of 1+1>2. Attempted tax arbitrage may fall into this category but for the wrong reasons.

So, if the regulators and governments allow the merger to proceed, it is our view that Pfizer may have just bitten off more than they can chew…doing something for tax reasons alone is seldom a good reason.

This is true for both business and portfolio investing, “Tax alone shouldn’t drive the decision.”

The complexities associated with merging two companies of enormous size and differing cultures across multiple jurisdictions will alone present its own series of problems and if there are no true benefits to be ground out then it’s a deal that leaves us lukewarm.

Which is why prudent and active portfolio management is the key to long term investment success for any portfolio. The underlying fund of the TAMIM Global Equity High Conviction IMA is performing better than just about any international fund over the medium and long term (go ahead and compare us to your other favourites). After extracting some handsome gains in which we believe was a lower risk investment, Pfizer is now no longer a part of our investment portfolio and we will happily leave any further upside to the investor who was kind enough to take the stock off our hands.
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The above scenario and resulting thought process is how we encourage you to think about your personal investments. If there are clouds gathering over a company within your portfolio, don’t ignore the warning signs as we are starting to see happening with Pfizer. This even more true if tax implications are the sole reason for your decision.