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When mega-mergers are less than the sum of their parts

Pfizer Inc. says it wants to pay more tax in the U.K., so much more that it will shift its legal domicile to Britain if its proposal to take over AstraZeneca PLC is accepted. You would think the British would be pleased, with the added schadenfreude of seeing a large U.S. company turn its back on Washington. Instead, Pfizer has been pelted with mud, accused of cynically using the U.K. as a tax haven while harbouring secret plans to decimate AstraZeneca's research operation, killing British jobs and science. It sounds like politics as usual (familiar to Canadians): a U.S. company threatens to take over a national corporate darling that has found itself in a vulnerable place. But this row is bigger than a storm in Westminster's teacup. It is exposing global fault lines: should a state use tax incentives to promote its own knowledge economy in a world where large companies prefer short-term shareholder return to national loyalty, or even the public good?

Initial signals from Downing Street suggested that ministers were equable towards Pfizer. But prime minister David Cameron was naive in thinking he could stand aloof from a transaction with large implications for British science. Pfizer has a lousy reputation in Britain; it used its scythe to topple 1,500 jobs in Kent three years ago when it shut its laboratory in Sandwich, a facility famous for inventing Viagra. Adding to suspicion is the behaviour of Kraft Foods Group Inc., the U.S. food combine which took over Cadbury giving written assurance that it would keep open a chocolate factory. Within weeks of the bid's closure, the American company shut the doors and laid off 400 workers.

The pharma bid has been a gift for the Labour leader Ed Miliband, who accused the prime minister of being Pfizer's cheerleader and of failing to support AstraZeneca's long-term research and development plan. Mr. Miliband wants Pfizer's bid be subjected to a national interest test. In an attempt to quell the row, Vince Cable, the business secretary said he was "open-minded" about forcing Pfizer to jump through a "public interest" hoop. Meanwhile, a former AstraZeneca CEO, Sir David Barnes, said the American company was a "praying mantis" that would "suck the lifeblood" out of AstraZeneca. The top brass of both Pfizer and Astra are soon to be called before the Business Select Committee of the House of Commons for a grilling.

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Beneath the polemic lies a British legal box and an American cash mountain. The standard U.S. corporate tax rate of 35 per cent is high and American companies have for decades been seeking boltholes to keep profits abroad; the total corporate pile remaining at arm's length from the Internal Revenue Service is now said to be approaching $1-trillion (U.S.). One popular manoeuvre is "inversion," where the U.S. company acquires a foreign domicile through takeover. Pfizer has $49-billion in cash, most of which is likely to be offshore, and Britain's corporate tax rate will fall to 20 per cent over the next couple of years. Even more interesting is the Patent Box, a regime which came into force in the U.K. last year. By 2017, the tax rate on profits earned from U.K. or EU patents will be as low as 10 per cent.

It could be lovely for Pfizer: a much lower general corporate tax rate, the ability to import profits tax-free, access to the cash pile without a tax penalty and the Patent Box as the icing on the cake. The question being asked in Britain is what the U.K. gets in return for handing over AstraZeneca, and the answer is, not a lot. There is no guaranteed investment, just a vague assurance that the merged company would retain a fifth of its R&D workforce in the U.K. . Moreover, we know that the U.S. drug company has form in the school of slash and burn. Pfizer bought Wyeth for $68-billion in 2009. At the time of the takeover the two companies' aggregate payroll was about 130,000. By the end of last year Pfizer's global headcount had fallen to 77,000. The 2011 restructuring in which the Viagra labs were sacrificed enabled the company to save $1.5-billion, which was applied to a $5-billion share buyback.

David Cameron and his colleagues are right to turn a blind eye to the nationality of corporate behemoths. AstraZeneca's British credentials are flimsy. It was born of the merger of ICI's pharma business and a Swedish drugs company. About half of the shares are owned by U.S. funds. And there is merit in the strategy of playing open house to legitimate investors, regardless of race, faith or passport. Consider the "British" motor industry, which is this year racing past France in vehicle output but which is almost entirely owned by Indian, Japanese and American firms. Tata Motors Ltd., which owns Jaguar Land Rover, is successfully rebuilding the brands it acquired with huge investments; Tata in Britain is not an empty corporate centre doing licensing deals with offshore manufacturing subsidiaries.

But the accent should be on investment, and this is where the Pfizer strategy is fundamentally flawed. Theirs is a business model based on acquiring patentable assets and sweating them with aggressive sales and marketing. Without invention, however, there are no drugs to sell. Worldwide, the pharmaceutical industry is struggling and Pfizer seems to believe the answer is to achieve scale in order to square up to powerful state-owned buyers, such as Britain's National Health Service, while squeezing more dollars out of shrinking assets. A government's proper answer to such a venal organism is simple: if you believe in research, show us the money.

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About the Author

Carl Mortished is a Canadian financial journalist and freelance consultant based in the U.K. With a career spanning investment banking, journalism and consulting for global companies, he was for many years a financial writer and columnist for The Times of London. More

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