DOTW Keeps Tabs As Tax Trimming Fuels Deals

As an industry, biopharma actually fares pretty well when it comes to taxes. Among profitable companies, biotech and pharma have some of the lowest effective U.S. tax rates compared to companies in other sectors. But that doesn’t mean they have stopped working to push their tax rates even lower.

Along with a recent ramp-up of the usual strategies, such as buying companies or assets based in low-tax locales or moving intellectual property there, the industry also is starting to take advantage of the newest twist on tax inversions – in which two companies in high tax locales, only one of them the U.S., merge and create a new company based in a low-tax country.

The specialty pharma consolidation frenzy is driven in part by tax benefits derived from buying companies in lower tax jurisdictions like Ireland. The spec pharma with the lowest tax rate wins – or at the very least earns the right to leverage all that cash on their books to gobble up higher tax rate competitors, thereby making higher margins on the same products.

Valeant is the obvious winner on this front; it will have an astonishing 2% tax rate in 2014, according to data from RBC Capital. But most recently, taxes were also a factor in the Actavis purchase of Forest Laboratories Inc. Actavis had already lowered its tax rate with the acquisition of Irish-headquartered company Warner Chilcott that completed last fall. Now Actavis can apply that reduced tax rate to a product portfolio that will encompass Forest. Prior to the deal announcement, RBC expected Forest would have a 24% effective tax rate in 2014 and that Actavis’ would be 17%.

And, of course, Perrigo is also a newly Irish company, with its purchase last year of the floundering Elan. But there aren’t a lot of direct routes left to Ireland. The largest independent, public Irish therapeutics company is drug delivery company Alkermes; it’s only one of six remaining that also include another drug delivery play Merrion Pharmaceuticals as well as antibody company Prothena, according to the Strategic Transactions database.

(In Ireland, all roads lead back to Elan. Alkermes garnered its Irish locale after a 2011 merger with the drug delivery unit of Elan, while Prothena is the 2012 spin-out of Elan’s drug discovery business. Merrion is also based on IP purchased from Elan.)

Most biopharmas count themselves lucky to have an effective tax rate in the teens – or even the low 20s. The big biotechs with the highest anticipated 2014 effective tax rates are Biogen Idec Inc. at 27% and Gilead Sciences Inc. at 25%, according to RBC. Between them they’ve had two of the most successful launches in recent years for Biogen’s Tecfidera (dimethyl fumarate) and Gilead’s Sovaldi (sofosbuvir).

Intellectual property for each of these products is domiciled in Ireland in an effort to curb tax expenditures. But that’s a long-term solution that could take years to work. Biogen had a 28.8% non-GAAP tax rate in the fourth quarter. Due to a larger percentage of its profits coming from the U.S. with the Tecfidera launch, the biotech expects the rate to remain at this level through 2014 but for it to subsequently decline in the following two years.

Alexion beefed up its Irish and Singapore operations last year and in January bought an Irish vialing facility for its Soliris (eculizumab). These efforts resulted in tax benefits that are expected to give it a 2014 non-GAAP tax rate of 11% to 12% (GAAP tax rate of 20% to 25%). That’s down from a whopping 51.9% effective tax rate in 2013, which translated into an income tax provision of $273 million. Alexion’s non-GAAP rate is expected to rise to 13% to 14% in 2015 and 16% to 18% in 2016 and beyond, since some benefits are only short-term tax credits.

The most creative tax tactic in the sector is the recent Endo-Paladin deal. The usual approach to tax inversion is for a U.S. company to become the subsidiary of a foreign company. The latest twist on this long-standing move, the third deal of its kind according to RBC, is exemplified by the Endo-Paladin merger, in which a U.S. and Canadian company are merging to form a new entity – in this case, an Irish company.

One risk of being overly imaginative with corporate tax strategy is always bad publicity, as it can trigger allegations of being a ‘tax avoider’ or, even worse, attract the tender attentions of the IRS. Those issues make it difficult for the big multinationals to be very aggressive on the tax front, although becoming enormous hasn't slowed Valeant’s efforts on this front.

The highest corporate income tax rate in the United States is around 40%, including federal, state and local taxes. But at $242 billion in 2012, corporate income taxes are a small percentage of U.S. federal receipts compared to the $1.1 trillion in individual income taxes and $845 billion in social insurance taxes during that year, according to a recent Government Accounting Office report. Since the 1980s, corporate taxes have ranged from roughly 6% to 15% of federal revenue.

Ireland isn’t the only useful tax locality – the top four are the UK, Ireland, the Netherlands and Switzerland, according to RBC. These countries had a 2013 corporate tax rate of 23%, 12.5%, 25%, and 18%, respectively, according to data from KPMG.

Ernst & Young’s Mitchell Cohen, the life sciences global tax leader at Ernst & Young, also includes Belgium (35%, with substantial patent and R&D related deductions and credits), Singapore (17%) and Puerto Rico (20% to 30%) among the ranks of countries with a significant life sciences presence that provide tax benefits.

Among profitable companies overall, the average effective tax rate is 26.6%, according to a current dataset from Aswath Damodaran, a professor of finance at the Stern School of Business at New York University. The profitable pharma companies in his dataset had a 22% average effective tax rate, while the money-making biotechs were at an average of 17.4% That puts both groups in the bottom one-third of corporate tax paying sectors.

And while DOTW can't promise that you'll personally enjoy an effective tax rate of 2% this season, we do want to send you off with this week's deal news. Please read on to discuva the latest, including a pair of preclinical deals and another two that were called off in this week's edition of. . . .

Celgene/Abide: Celgene likes to keep all its options open – to acquire companies, to acquire programs and to license programs. In its latest R&D deal with the preclinical Abide Therapeutics, disclosed on Feb. 28, it included an option to purchase its biotech partner as well as an option to license the rest-of-the-world rights on the first two programs to reach the clinic. Abide’s most advanced compound, AB101131, is expected to enter the clinic in 2015. The biotech expects to get three or four additional candidates into the clinic under the collaboration.  Its technology selectively targets serine hydrolases to develop new treatments for inflammation and immunological disorders. Founded in 2011, Abide was seeded by venture firm Cardinal Partners. Celgene and Cardinal Partners both participated in an undisclosed equity financing concurrent with the deal. Other terms of the deal, including the upfront, also remain undisclosed. Abide is headed by Alan Ezekowitz, an entrepreneur-in-residence at Cardinal Partners who became the biotech’s president, CEO and co-founder. Prior to that, he was at Merck Research Laboratories, the research division of Merck & Co. Inc., as SVP and franchise head of bone, respiratory, immunology and endocrine. Abide’s platform is based on work by Professors Ben Cravatt and Dale Boger of the Scripps Research Institute. The biotech secured its first big biopharma deal last May; it partnered with Ezekowitz’ former employer, Merck. In that deal, it garnered an undisclosed upfront and milestones of up to $430 million to discover, develop and commercialize small molecules against three novel targets to treat metabolic diseases with a focus on type II diabetes. In the last few years, Celgene has done at least three prior deals that included an option to purchase the company: an October 2013 deal with cancer and fibrotic disease company PharmAkea Therapeutics, a July 2013 partnership with toll-like receptor agonist developer VentiRx Pharmaceuticals, and an October 2012 deal with selective small molecule histone deacetylase (HDAC) inhibitor developer Acetylon Pharmaceuticals. - Stacy Lawrence

Roche/ Discuva: Roche and U.K. biotech Discuva are collaborating on the discovery and development of new antibiotics to treat multi-drug resistant gram-negative infections using Discuva’s Selective Antibiotic Target Identification technology platform. SATI uses next-generation sequencing and bioinformatics to identify bacterial targets and select from among them promising drug development candidates. The deal, announced on Feb. 28, fits well with Roche’s revamped research strategy in infectious diseases, a field its R&D organization exited more than 20 years ago, but recently has re-entered. The new, narrower focus is on multi-drug resistant, pathogen-specific, hospital-directed therapies, rather than broad spectrum antibiotics that were Roche’s original focus. Companion diagnostics, an area of strength due to Roche’s long experience in molecular diagnostics, will be important in identifying pathogens. In an October 2013 meeting in New York, Roche’s head of research and early-stage development John Reed outlined his organization’s priorities, noting that the antibiotics field is attractive now in part because “the animal models are good in the clinical context” and the regulatory path is clearer, particularly for safety requirements, thanks to recent FDA guidance.” Discuva will receive an upfront payment of $16 million, as well as research fees and payments on multiple programs of up to $175 million per product upon achievement of certain development, commercial and sales milestones. It will also receive potentially double-digit royalties on product sales. Discuva uses proprietary methods built from recent genomic discoveries to identify targets that affect bacterial growth and viability, as well as related genes potentially associated with development of downstream resistance. The problem of multi-drug resistance to gram-negative infections is growing but has not received as much attention as gram-positive infections. Gram negative pathogens addressed by Discuva include Pseudomonas aeruginosa, Acinetobacter baumannii, Klebsiella pneumonia, Escherichia coli, and Neisseria gonorrhoeae. The company was founded in early 2012, with backing from New Wave Ventures. New Wave’s co-founder Tim Bullock is chairman of Discuva’s board; the amount his firm contributed to the start-up is not public. David Williams is an entrepreneur who founded Sareum, a U.K. oncology biotech that went public on AIM, and previously worked at Millennium Pharmaceuticals, Acambis, and Medivir. - Wendy Diller

Merck/Ariad: The fate of Ariad Pharmaceuticals’ mTOR inhibitor ridaforolimus is uncertain now that pharma partner Merck & Co. has decided to return rights to the cancer drug. Ariad revealed in its year-end financial release Feb. 25 that Merck is terminating a licensing agreement for the development and commercialization of ridaforolimus effective in November. The move creates “a new clinical and business opportunity for Ariad,” the company said in a statement, but management didn’t even mention ridaforolimus during a same-day conference call. Ariad is focused on the re-launch of Iclusig (ponatinib), which re-entered the U.S. market in January for the treatment of leukemia after sales were temporarily halted last year due to safety concerns. The company is also running clinical trials to meet FDA’s post-marketing commitments for Iclusig and to expand its label to new indications. Merck’s decision to end the agreement shouldn’t surprise investors, especially now that the big pharma’s oncology focus has shifted to its PD-1 immunotherapy program. Ridaforolimus was rejected by FDA in 2012 as a maintenance treatment for sarcoma after it failed to demonstrate a benefit on survival in a Phase III trial and only a limited two-week progression-free survival advantage. Under the original 2007 collaboration between the two companies, Merck paid $75 million upfront for development and commercialization rights to ridaforolimus and agreed to pay up to $452 million in development milestones and $200 million in R&D payments; the deal was revised in 2010 to give Merck global rights rather than a U.S. profit split. Merck paid out some $222.5 million in upfront and milestone payments during the life of the deal, according to the Strategic Transactions database. - Jessica Merrill

Teva/Andromeda: In a case of a “No-Deal” possibly leading to another deal – Andromeda Biotech reacquired rights to type 1 diabetes candidate DiaPep277, along with equity, from fellow Israeli company Teva. To undo the firms’ 2007 partnership around the human heat shock protein 60 (Hsp-60)-derived peptide, Andromeda will pay Teva total consideration of approximately $72 million in future installments based upon revenues or proceeds payable to its shareholders.That unraveling of a deal on Feb. 24 was followed by media reports Feb. 26 that Clal Biotechnology, another Israeli company which owns 96% of Andromeda, was working on selling Andromeda and the DiaPep277 program to an undisclosed U.S. biopharma for a price that might number in the hundreds of millions of dollars. At press time, however, a second transaction could not be confirmed. Andromeda said it will continue a 475-patient confirmatory Phase III trial for the candidate. The 24-month, double-blind, placebo-controlled trial is being conducted at more than 100 locations in North America, Europe, Israel and Argentina. Patient recruitment was completed in September 2012 and the trial is expected to produce data by the end of this year. The trial is studying DiaPep277’s ability to preserve the patient’s insulin secretion by the pancreas, with a primary endpoint of maintenance of glycemic control. - Joseph Haas

Thanks to 401(K) 2013 from Flickr for the use of the image, which we find both alarming and strangely beautiful.

A "Sophie's Choice" for Pharma in Tax Policy: R&D or Marketing?

The tax write off available for pharmaceutical marketing costs has been a popular political target for industry critics for more than 20 years—and all the moreso in the era of broadcast direct to consumer advertising. Many in Congress want to ban DTC ads outright; that almost certainly won’t pass First Amendment scrutiny, so making advertising more expensive by changing the tax code is an appealing alternative.

Still, while it makes a good talking point, advertising critics have never succeeded in pushing the idea through to enactment.

Now the Democratic leadership in Congress is considering a new twist, a proposal to give pharma companies a choice: write off R&D costs or write off marketing costs. Not both.

That, according to Polsinelli Shugart public policy group Chair Jim Davidson during his update to the DTC National Congress April 15, was an idea offered by former Rep. Rahm Emanuel during a closed door meeting with some advertising types last year.

The idea sure sent a ripple through the 400 or so pharma, ad agency and media attendees at the DTC Congress.

Emanuel has since left Congress to serve as chief of staff to President Obama, which does nothing to blunt concerns among advertisers about the potential for the tax policy proposal to slip into legislation this year, especially in the context of finding new revenues to cover costs of expanded health care coverage. (Read more about Emanuel’s recent statements here.)

Coalition for Healthcare Communications Director John Kamp noted the threat of Emanuel’s proposal, describing it as presenting a “Sophie’s choice” to industry by asking, in effect, whether companies love their marketing departments or their R&D organization more. It is a classic divide-and-conquer maneuver, Kamp says, since it is sure to exploit the tensions that already exist within pharma companies over that very question.

“Think about your own companies,” Kamp told the brand managers in the audience.

Well, it certainly got us to thinking…and quickly got us thinking that maybe this “Sophie’s choice” wouldn’t be all bad.

Now, let’s be clear: biopharma companies will fight this proposal, as will advertising and media companies. And, if history is any guide, they will win. Pharma, in particular, has a good track record in working the intricacies of tax policy. No reason to expect a different outcome here. Nor do we seriously think pharma should support a tax hike on itself in any event.

It is just that this could be a case where a policy threat would force a healthy business adjustment.

The new tax policy would, in effect, force pharma companies to choose between a reduced return-on-investment from their R&D or a reduced RoI on marketing, since the elimination of the tax deduction in effect amounts to a reduced return on the dollars devoted to the affected activities.

So the first step would be to force senior management to take a stand on which actually delivers a better RoI in the first place.

In some cases, it is easy. Most biotech companies, for instance, only wish they had marketing costs to write off, and even those that do wouldn’t have too much trouble choosing to keep writing off R&D. On the other hand, “specialty” companies like Forest or Ovation would surely want to write off marketing costs, since they tend to in-license late-stage projects rather than shoulder the full R&D burden themselves.

But what would Pfizer do? The company spends billions on R&D and billions on marketing, and so could ill afford to accept higher taxes on either front.

Surely one option would be to divide into smaller companies that more clearly fit the biotech (R&D-first) or specialty (commercial-first) models. That happens to be exactly what some of us have been suggesting for a long time now.

Indeed, one way to view the Pfizer/GlaxoSmithKline HIV partnership is as a baby step (or maybe a toddler step) in that direction. Glaxo/Pfizer HIV Inc. would surely choose to keep its R&D deduction. (As would, presumably, a stand-alone Pfizer oncology unit.)

Pfizer itself, on the other hand—if it indeed continues to consolidate towards a GE style health care marketing colossus—would probably end up protecting the deductibility of its marketing costs. In fact, its hard to see how R&D fits long term in that GE model anyway. (You can read coverage of Roger Longman’s latest take on this topic in “The Pink Sheet” here.)

See how fun it is to play what ifs?

And that’s the point. Pharma companies are right to oppose the policy, but there is surely value in playing out this “Sophie’s choice” anyway. It may turn out to be good business for pharma to focus on one side or the other of the great pharma divide between R&D and marketing, even if Congress doesn’t force that choice upon them.

Maryland First, Then The World?

Two recent stories in the Washington Post and Baltimore Sun about an overnight camp-out for Maryland state biotech tax credits caught our eye. We were curious. Did CEOs of the local companies wear pajamas on the street? Did you lose your place in line if Mother Nature called? Were any deals signed on hot dog wrappers at 4 am?

The Post and Sun suggested the scene recalled camping out for concert tickets. May we suggest another image: bread lines in the great depression.

After all, what we are talking about here is a $6 million tax subsidy. That's better than a punch in the nose, but worth lining up for? Well, in today's financing climate, it most definitely is. And expect to hear more pleas for new tax credits on the federal level soon.

Jonathan Cohen, president and CEO of Rockville, Md. diagnostic device firm 20/20 GeneSystems, tells us that he is part of an “an ad hoc coalition of small biotech companies” trying to get legislation introduced in Congress to establish a federal tax credit for biotechs. Cohen was the driving force behind Maryland’s Biotechnology Tax Credit, now in its third year and apparently more popular than ever.

Cohen says the goal is for a bill to drop this year, although that would be just the start of a much longer process. For now, he is mum on the details, other than to say the credit would be different in design from Maryland's. When there is more to report, we will.

While you wait, check out “The Pink Sheet” DAILY’s take on the spectacle of CEOs and other staff from about 14 biotechs lining up overnight outside the Baltimore offices of the state Department of Business and Economic Development.

--Joseph Haas