Ian Read, CEO of Pfizer, left, and Brent Saunders, CEO of Allergan, in front of Pfizer headquarters in New York after announcing their merger on Monday, Nov. 23, 2015.
Photograph by Bloomberg via Getty Images
By Jen Wieczner
April 5, 2016

The way their stocks are trading, it’s as if Pfizer never even met Allergan—let alone struck a $160 billion deal last year to do the largest merger the pharmaceutical industry has ever seen.

Allergan’s shares plunged more than 16% on Tuesday, after the U.S. Treasury Department proposed new rules to limit so called tax inversions—deals in which American corporations acquire a foreign company and then reincorporate overseas for the primary purposed of lower their tax bill.

Pfizer is reportedly considering abandoning the deal. Officially, Pfizer (pfe) and Allergan (agn) jointly said that they couldn’t “speculate” on whether the changes would impact their merger plans before they finished reviewing the rules. Investors, though, reacted as if the deal was already off the table.

Allergan’s stock was as as low as $230 on Tuesday. Pfizer’s stock price, meanwhile, rose nearly 3% on Tuesday, to $31.50. The drugmaker agreed in November to pay 11.3 of its own shares per Allergan share, which would translate into $356 per Allergan share. That means Allergan’s shares are about $126 lower than where they would trade if investors actually believed the deal would succeed—a gap so wade that it implies investors believe the deal is “95% dead,” according to Evercore ISI analyst Michael Craig.

Indeed, investors have been skeptical about the deal’s success ever since it was announced. And Allergan’s shares have been below Pfizer’s offer price for them for a while. But Allergan stock is now even cheaper than it was before rumors of a Pfizer deal first began to circulate last fall, which had caused the shares to rise. The selloff has also caused Allergan’s value to fall below what several Wall Street analysts (including at Cowen and RBC) think it’s worth as a standalone company—even if the Pfizer deal never happens.

Investors’ reaction stems from the perception that the Treasury may have just killed the merger, or at least made it a lot harder for Pfizer to reap the tax savings it sought, “potentially derailing” the deal, according to analysts at Jefferies.

At issue is how much Allergan, which is based in Ireland, will own of the combined company when the deal closes. In order for Pfizer to benefit from Allergan’s lower foreign tax rate through the deal, Allergan shareholders need to own at least 20% of the combined company, according to Treasury rules. While the companies thought they had safely cleared that threshold—with Allergan shareholders owning about 44% and Pfizer shareholders owning 56% of the new company—the Treasury’s new proposal threatens to throw that math out the window.

That’s because the Treasury’s new rules would exclude Allergan’s acquisitions of U.S. companies in the last three years—deals that not only made Allergan significantly bigger, but also allowed it to move to Ireland in the first place, through an acquisition of Warner Chilcott in 2013 (by Actavis, the company that bought Allergan in 2014).

(For a timeline of Allergan’s deals, see “From Actavis to Allergan: One pharma company’s wild dealmaking journey.”)

If the shares that Allergan acquired through those deals don’t count, it may not have enough total shares to meet the required threshold of ownership in Pfizer. For example, if you remove Actavis’ acquisition of Allergan, the Irish company’s stake in Pfizer drops to a third, according to Credit Suisse. But if you also exclude Actavis’ Warner Chilcott deal, the stake drops to just 19%—not enough to qualify Pfizer for Allergan’s lower foreign tax rate. “At this point we believe it is unlikely the deal will close,” Credit Suisse analysts led by Vamil Divan wrote in a research note.

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