Pfizer Finance and Accounting - Case Study Example

Finance and Accounting Finance and Accounting Introduction Pfizer is a multinational pharmaceutical company of America. Its headquarters is in New York. Pfizer mainly produces and develops vaccines and medicines that are available worldwide. Pfizer was alleged for carrying out illegal marketing of the drug related to arthritis. Astra Zeneca is a multinational pharmaceutical company of Britain. It has a portfolio consisting of a wide range of drugs. This company was founded with the merger of UK based Zeneca group and Sweden based Astra. The paper discusses that Pfizer was unsuccessful in taking over Astra Zeneca. Astra Zeneca has declared the bid option provided by Pfizer as inadequate. Debt and equity are the two pillars of capital structure. Between the two, debt financing is relatively more important. The interest rates increases in accordance with high public debt and lays the path of inflation within the economy. Pfizer has the intension to reduce the corporate tax rate and therefore it wants to overtake Astra Zeneca. Capital gearing can be defined as the means of financing that establishes the relationship between debt and equity for calculating the capital structure of the company. Capital gearing increases the wealth of the shareholders. Therefore Pfizer has adopted the concept of capital gearing. Discussion Concepts of value and wealth generation incorporating finance and business Wealth generation or maximisation is followed or adopted by the organisation in order to increase the capital gain of the shareholder and the net value of the business. Pfizer has developed operational models for facing the challenges that generally affect or influence the corporate growth. By identifying the economic and financial requirement the growth and development of Pfizer is not always successful. There are many factors that are required to be considered for maximizing the corporate wealth that deals with acquisition, assets and liabilities, contingencies, financial statements and pricing. Different strategies have been formulated by Pfizer for maximizing the wealth of the shareholders. The generation of wealth indicates that the market share of the company is large and stable. The wealth generation for incorporation in finance and business plays an important role because maximizing the value of the shareholders play an important role for the pharmaceutical companies because the pharmaceutical companies are mainly associated with dividends, merger and acquisition and also share buybacks. In order to develop and increase the value of the life saving drugs of the pharmaceutical companies it is required to increase the wealth of the shareholder (Zoan, 2014). Creation of value for the customers and the shareholders increases the stock price of the organization. In finance the value is considered to be generated when the business is capable of earning revenue more than its expenses. Value creation helps in measuring the financial performance and cutting down or reduction of the cost or enhancing long term growth and competitiveness of the organization. The company aims to provide value to its shareholders by focusing on the functioning of the organization effectively and efficiently. In order to increase the opportunities for innovation and gain competitive advantage Astra Zeneca creates opportunities for formation and maximisation of value and invest for the innovation in pharmaceuticals AstraZeneca is capable of utilizing the skills to gain the advantages of the value creation in the long term. Pfizer also focuses on creation of value by undertaking innovation and expansion of the pharmaceutical business. It is engaged in carrying out research and development for delivering high value for the vaccines and the medicines. Figure 1: Risk related to shareholder wealth issues Is levering up the balance sheet justified for acquisition of Astra Zeneca by Pfizer? Pfizer is considered as the largest and the most famous drug maker of US. Pfizer has established and fixed a ceiling on the amount that it is ready to provide for acquiring the UK based pharmaceutical company Astra Zeneca. But Pfizer was not ready to exceed its limit Pfizer commented that its intention of merger was not successful. It was the issue related to the price that prohibited the two companies. Pfizer expected that the merger will provide benefit as its shareholders will be able to retain and maintain control or authority over the company. It mainly allows the recipients to widen the investment (Vellacott, 2014). Figure 2: PEE US (Pettypiece, 2014) Pfizer is adopting the strategy to lower its tax rate and to gain the competitive advantage by Astra Zeneca which is conducting experimental drugs for carrying out the treatment that mainly contributed to the wide portfolio of Pfizer. Pfizer has declined its shares to less than 1% to 29.43 $ at the time of closing of the stock exchange in New York and the company has gained the increase in the share price by 3.6%. Therefore Pfizer proposed that it would take more debt in order to maintain investment grade at the risk of carrying out right deal required for credit rating purposes. But the capital structure off the company is composed of the debt and equity. Pfizer has more of debt as compared to its equity that is leverage buyout. The increase in debt will increase the payment of interest of Pfizer which will lead to inflation as a result the purchasing power will decrease and therefore the corporate debt of Pfizer will also increase. Therefore in order to decrease the corporate tax and increase and expand its product portfolio Pfizer preferred to undertake merger or takeover of the UK based pharmaceutical company Astra Zeneca. Due to the rejection of the merger deal offered by Pfizer, Astra Zeneca had to face conflict with its shareholders. Pfizer has aimed to become the largest pharmaceutical company around the world but to the utter dismay it had to face the disappointment by the rejection of offer by Astra Zeneca (Sharman and Milne, 2014). How shareholders should evaluate the value of bids for shares they hold In any financial decision taken by the company management the consideration of the shareholder’s value comes first. Share holders are considered as principal and the company management as agent. The duty and moral obligation of the agents lie in doing business so that they are able to maximize shareholder’s value. Recently Pfizer made a bid to acquire Astra Zeneca by making an offer price of £55 per share. However the bid was rejected by the management of Astra Zeneca. In rejecting the bid by the Pfizer the management of Astra Zeneca stated that it felt that it will be able to create more value for the shareholders independently, the takeover would limit its ability to bring out drugs quickly to the market and the deal carried with itself a big execution risk (BBC news, 2014). However most of the shareholders of Astra Zeneca felt that if Astra Zeneca would have accepted the takeover bid it would have created more value for the shareholders. In fact after it was evident that the bid would not occur the share lost 11% in value and £6.75 billion was wiped off company’s value. The main part in the decision is how to correctly value a company. There are several ways to value a company but the problem arises with some core competencies that cannot be valued easily. This becomes a problem when a rival company goes in for M&A bid. The problem is whether the company is correctly valued by the acquirer firm or not and that actually depends on how share holders consider the fact. Impact of capital structure on shareholder wealth The capital structure has a good level of impact on the shareholders values of a particular company. Studies have shown that capital structure is very much correlated to the firm’s value and shareholder wealth. Capital structure refers to the various sources that are used by the firm for financing its activities. The various sources are debt (short term and long term), equity (common and preferred). The firm can raise debt capital through taking loans from banks or issuing of bonds. In contrary the firm can raise equity capital by issuing shares to the general public (Akhtar and Mujahid, 2014).). Pfizer wants to acquire AstraZeneca. Pfizer CFO has said that even if the company has to take on more debt to acquire AstraZeneca it is ready to go for it provided the outcome will give higher value to the share holders of Pfizer. If we analyze the capital structure of Pfizer we find that the company has higher levels of debt than equity. So the company has already a levered balance sheet. The company says that by acquiring AstraZeneca it will be able to shift its headquarters to UK and reduce taxes because the tax rate of UK is lesser than that of USA. If a company goes in for high level of debt then accordingly the interest on the debt also increases. When inflation increases the central banks will try to curb inflation by increasing interest rate on loans. If interest rate on loans increases, the cost of debt capital will also increase. In order to avoid this effect the company wants to shift its operations to UK. Each mode of financing of merger and acquisition has advantages and disadvantages associated with it. However the advantage and disadvantage of financing a particular type of merger depends on that particular merger. For example if the acquirer uses cash to finance its merger then the advantage is the simplicity which provides for greater success of the activity. However the disadvantage of using cash as financing option to the target shareholders is that they may be liable for capital tax gain. Figure 3: UK merger activity: 1970–2010 Impact of M&A activity upon shareholder wealth generation For a public limited company shareholders are the main owners of the company. They act as the principal and the managers of the company as their agents. The preliminary function of the company management is to maximize share holder’s value. A dissatisfied share holder is not what a company ideally wants. So before going in for a merger and acquisition the company often goes in for to see whether the particular activity will give rise to maximum shareholder value. However the problem that often arises is called agency problem. According to this theory the managers often react to mergers and acquisitions or any other activity by looking at how to maximize their own wealth and overlook shareholder’s value maximization proposition. To overcome this problem there are several counter measures that have been suggested. The mechanisms to avoid this problem focus on greater monitoring of the activities of the managers. A simple way to do so is to implement a board of directors in the company. The function of the board of directors is to meet often to discuss the operations of the company managers and whether the managers are functioning in the best interest of the shareholders. However the question that one should ask in this context that is shareholder’s wealth maximization is the best way for the companies to decide whether to go in for a merger and acquisition or any other corporate decision. John Kay is of the opinion that firms which go in for a decision based on the sole objective to maximize the share holder’s value comparison to those companies that focus on vision and excellence first shareholder’s wealth maximization comes up automatically. To consider the impact of the merger and acquisition decision on shareholders’ value there are two considerations that has to be considered. One is short term and other is long term impact. A study conducted in the UK markets to analyze the impact of merger and acquisition on short term share holder’s value found that announcement of merger acquisition has a positive impact on the shareholders value in terms of the abnormal returns on the shares of the company (Bartholy & Flugt, 2009). A study to analyze the impact of merger and acquisition on shareholder’s value in the long run found that merger and acquisition activities add to the share holders value both in short term and long term. It was found that the better performance of the merged entity in longer term over their counter parts was not due to profitability or operating efficiency but due to increase in market share, outgrowing the competitors in terms of revenue and employment (Clare and Faelten, 2012). Conclusion In case of merger and acquisition the capital structure is taken into consideration which includes the combination of the debt and equity. Both the equity and debt financing has advantages and the disadvantages. But the selection of either debt or equity is based on the financial structure and performance of the company. The various credit rating agencies such as Standard and poor, moody rate the performance of the companies on the basis of the case inflow, bond valuation and share value in the stock market. The shareholder value and generation of wealth is considered as an important aspect in case of the merger and acquisition. Therefore in the case of Pfizer unsuccessful takeover of Astra Zeneca it can be concluded by the fact that Pfizer commented that Astra Zeneca faced extraordinarily high risk at the beginning or at the early stage and it required huge amount of investment and it suggested that the offer that is provided by Pfizer will assist the UK based pharmaceutical company Astra Zeneca to face the struggle and competing with the large number of national players in the changing and emerging market. References Akhtar, K. and Mujahid, M. (2014). Impact of Capital Structure on Firms Financial Performance and Shareholders Wealth: Textile Sector of Pakistan. International journal of learning & development. 4(2). 27-33. Astra Zeneca. (2011). AstraZeneca Annual Report and Form 20-F Information. Retrieved from http://www.astrazeneca-annualreports.com/2011/documents/pdfs/annual_report_pdf_entire.pdf. Bartholy, J., & Flugt, C. (2009). Shareholder wealth effects of mergers and acquisitions: An empirical investigation of short-term performance in the European Market. Retrieved from http://pure.au.dk/portal/files/8464/217003.pdf BBC News. (2014). AstraZeneca rejects final takeover bid from Pfizer. Retrieved from http://www.bbc.com/news/business-27466278 Clare, A., and Faelten, A. (2012). M&A in the UK: A study of post-transaction shareholder wealth creation, company financial performance and employment. Retrieved from http://www.mfsociety.org/modules/modDashboard/uploadFiles/conferences/MC19~508~p16uhuqrt4vhkqjuh1vqo71mjh1.pdf Pettypiece, S. (2014). Price the reason Pfizer-Astra Zeneca deal died. Retrieved from http://www.bloomberg.com/news/2014-06-11/pfizer-cfo-says-astrazeneca-deal-broke-down-over-price.html. Sharman, A. and Milne, R. (2014). Pfizer disappointed at AstraZeneca’s lack of engagement. Retrieved from http://www.ft.com/intl/cms/s/0/66acf760-da66-11e3-a448-00144feabdc0.html#axzz3MirDAizM Vellacott, C. (2014). Shareholders disappointed by AstraZeneca rejection of Pfizer. Retrieved from http://finance.yahoo.com/news/shareholders-disappointed-astrazeneca-rejection-pfizer-090510354.html Zoan, N.G. (2014). Finance - Professional Essays and Assignments. New York: Zoan NG. Read More