Question

On Monday, January 26, 2009, Pfizer (NYSE: PFE), the world’s largest pharmaceuticals group, announced that over the weekend it had reached an agreement to acquire Wyeth (NYSE: WYE), one of the largest research-driven pharmaceutical and health care products companies. The deal would be the eighth-largest, M&A involving a US target, and the third largest globally in the pharma industry. Pfizer had been under pressure to re-invent itself, in particular because patents on several of its blockbuster drugs, currently generating a large fraction of the revenue, were due to expire in the coming years, meaning that revenues from sales of those drugs were expected to drop dramatically. Analysts argued that buying Wyeth would help Pfizer diversify its revenue sources and thus soften the expected blow to revenues and EPS from patent expiration. In addition, Wyeth’s expertise in vaccines would allow Pfizer to expand rapidly in biological medicines, a fast-growing, profitable niche in the industry that Pfizer had had little presence in. Finally, the merger would allow Pfizer to cut 15% of its global workforce, resulting in an expected reduction in operating costs totaling $4Bn over three years. Specifically, 50% of the cost savings would be realized by the end of year 1, 75% by the end of year 2, and 100% by the end of year 3. The deal would be financed with 2/3 equity and 1/3 debt. Assume that the risk-free rate is 1.67%, the market risk premium is 8.5% and the corporate tax rate is 34%. The following table reports some financial characteristics of Pfizer and Wyeth:

	Pfizer (NYSE: PFE)	Wyeth (NYSE: WYE)
Share price on Jan 16, 2009	17.13	38.54
No. of shares (Bn)	6.74	1.33
Total debt ($ Bn)	16.35	0
Equity beta	0.61	0.42
Cost of debt (%)	3.15%	4.18%

It is recommended that you answer the following questions in the order they are asked. In answering each question, you can use information from proceeding questions, but not from subsequent questions. For example, in answering question (c) you can use information that you learn from question (b), but not what you learn from question (d).

(a) Explain why the following are or are not good reasons for Pfizer to acquire Wyeth:

To diversify revenue sources in anticipation of patent expiry

(ii) To gain entry into the biological medicine sector

(iii) To cut costs by exploiting synergies (

b) Find the WACC and the unlevered cost of capital for both Pfizer and Wyeth as stand-alone firms pre-merger.

(c) Assuming that synergies in the merger have the same risk as that of Wyeth’s cash flows, find the WACC and the unlevered cost of capital for the synergies.

(d) What is the total value created in this deal?

(e) Is the value created in the deal (estimated in (d)) higher or lower than that in an average merger?

(f) What is the maximum cash price that Pfizer can afford to pay for Wyeth?

(g) Suppose that the actual takeover price was $50.19 in cash per share of Wyeth. How does the premium offered to Wyeth’s shareholders compare with that in a typical merger?

(h) When the deal was announced on Jan 26, 2009, Wyeth’s share price fell from $43.43 to $43.09. Why?

(i) In reality, Pfizer offered to pay with a combination of cash and shares. Specifically, each Wyeth share would be exchanged for $33 in cash and 0.985 of Pfizer shares. On Jan 27, Pfizer’s share price was $15.49, and Wyeth’s share price was $43.89. Were Wyeth shares on that day worth more or less than the value of the offer? Why?