Drug giants Pfizer, Allergan in 'friendly' merger talks

Drug giants Pfizer and Allergan are weighing a massive merger in a deal that would deliver a sharp jolt to an industry accustomed to shakeups and could also stir up political division over U.S. tax policy.

The potential combination would easily qualify as the largest merger or acquisition of the year in business, with both pharmaceutical companies combining for a market capitalization of nearly one-third of a trillion dollars.

But it could provoke political dissension if it's structured as a corporate inversion — a tax maneuver which a company strategically acquires a foreign entity and then legally changes its headquarters to the target's foreign base to save on its U.S. tax bill.

Pfizer CEO Ian Read has publicly blasted the U.S. tax code for putting American companies at a disadvantage.

"This fits nicely for a tax inversion deal," S&P Capital IQ analyst Jeffrey Loo said in an interview. "Clearly that’s a goal of theirs."

Dublin-based Botox maker Allergan (AGN) said in a statement that New York-based Pfizer (PFE) approached it about a possible deal and they are engaging in "preliminary friendly discussions" about a combination. Pfizer distributed a similar statement.

"No agreement has been reached, and there can be no certainty that these discussions will lead to a transaction, or as to the terms on which a transaction, if any, might be agreed," Allergan said. "The company will not comment on speculation regarding the terms of a potential transaction."

There was no immediate indication of how much Pfizer might pay for Allergan. But Allergan investors welcomed the news, driving shares up 9% to $311.54 in mid-day trading Thursday, and Pfizer shares fell 1% to $35.12. The Wall Street Journal first reported news of the talks Wednesday night.

One possibility is that Pfizer could split into two companies after completing the deal — one for "innovative products" and another for "established products," Loo said. Job cuts and plant closures are a strong possibility if the two companies combine, he said.

The U.S. Treasury Department last year announced plans to impose tax penalties for any U.S. company that completes an inversion in which its original shareholders end up owning more than 60% of the new company.

Accordingly, Credit Suisse Vamil Divan said in a note to investors that Allergan represents one of the only potential targets for an inversion because of Pfizer's size.

Pfizer, which paid an effective tax rate of 25.6% in the second quarter, last year ditched an attempt to take over U.K. drug giant AstraZeneca in a deal that could have led to an inversion.

Divan said Pfizer could probably meet the Treasury Department's inversion threshold with an acquisition involving mostly stock.

As an alternative, though, Divan said it's possible Allergan could complete a "creative deal" in which it acquires Pfizer, even though Pfizer's market capitalization before the talks were revealed was $218 billion to Allergan's $113 billion.

That would "then avoid many of the issues of trying to complete a high-profile inversion," Divan said.

One factor to watch is the possibility of political action on inversions. The Obama administration has urged Congress to make inversions more difficult.

Pfizer CEO Ian Read told investors on Monday that if the company were to do an inversion, "I'd prefer it to be done under the present Congress" because otherwise "you're at a risk for the new Congress coming in and making changes in the rules."

Pfizer's top revenue-producing drugs include a pneumonia vaccine, pain treatment Lyrica and erectile dysfunction drug Viagra. But the company's patent on cholesterol drug Lipitor, once the best-selling drug in the world, expired a few years ago, dealing a sharp blow to revenue and profits.

The company has sought growth primarily through acquisitions in recent years. Allergan's top drugs by revenue are wrinkle treatment Botox and dry-eye treatment Restasis.

Like much of the pharma business, Pfizer and Allergan have undergone significant changes. Pfizer has slashed thousands of jobs in R&D and manufacturing. Allergan recently announced plans to sell its generic drug business to Israel-based Teva Pharmaceutical Industries for $40.5 billion.

Allergan reiterated Thursday that it remains "strongly committed" to the Teva deal, which is expected to close in the first quarter of 2016.

“An acquisition of Allergan by Pfizer makes sense," Edison Investment Research analyst Maxim Jacobs said in a research note. "Pfizer desperately needs a large acquisition and the resulting synergies to reinvigorate its tepid earnings growth rate."

Follow USA TODAY reporter Nathan Bomey on Twitter @NathanBomey.