Biotech Values

[DewDiligence]

Dividend May Test Pfizer

[PFE has mountains of cash, but it’s in the wrong places.]

http://online.wsj.com/article/SB121245147450039769.html

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Company's Funding of Generous Payout Could Face Hurdles

By AVERY JOHNSON and JOANN S. LUBLIN
June 3, 2008

Pfizer Inc., stuck in a rut of stagnating revenue and profit as it struggles to find new drugs, is facing another headache: how to keep funding its generous dividend.

The $8 billion in dividend payments Pfizer made to shareholders last year is widely considered to be among the few reasons many investors still hold the pharmaceutical giant's stock. At 6.67%, its dividend yield -- a gauge of investor returns -- is well above the drug-industry average of 3.37% and 2.18% for the Standard & Poor's 500.

Some on Wall Street worry that the payout, the industry's richest, may be in jeopardy in coming years because of the limited amount of money Pfizer is thought to hold and generate in the U.S. [I.e., available cash in PFE’s foreign subsidiaries can’t be used to pay the dividend without incurring heavy taxation when the cash is repatriated.] Pfizer's board of directors is keeping a close eye on the company's ability to maintain the dividend because "it has been a floor for the stock," a person close to the board says. Without that floor, some Pfizer directors worry the company's shares, now trading at a 10½-year low of $19.18, would plunge to $10 or $12.

So far, Pfizer has continued to assure Wall Street that the dividend is safe, projecting that it will grow 10% this year. In an interview, Frank D'Amelio, Pfizer's chief financial officer, said the company would continue the payout at least at current levels short of "significant events," such as a major economic downturn.

On the surface, cash wouldn't seem to be a problem for Pfizer. As of the end of last year, it held $25 billion in cash and short-term investments. But, most of that money is outside the U.S., and Pfizer probably would have to take a big tax hit to repatriate it, which in turn could hurt its earnings, says David Risinger, a drug-industry analyst at Merrill Lynch.

The dividend concerns underscore the strategic impasse at Pfizer, the world's largest drug company by sales. With its $13-billion-a-year cholesterol drug Lipitor set to face generic competition as early as 2010, Chief Executive Jeffrey Kindler is having trouble persuading investors that he has figured out how to keep the company growing.

Last month, prospects for one of Pfizer's few promising new drugs, the smoking-cessation medicine Chantix, were damaged by a report showing it has been linked to a large number of potential side effects, ranging from heart problems to seizures, since its 2006 launch. The drug has already been associated with depression and suicidal thinking.

Coming on top of the Chantix scare, the dividend issue is adding urgency to Wall Street's calls for Mr. Kindler to do something more drastic to jump-start the company's growth. Ideas circulating among analysts range from spinning off some businesses, such as animal health or oncology, to selling enough assets to become a leaner and more attractive takeover target.

Analysts' persistent questions about Pfizer's cash situation and ability to fund its payout have rankled Mr. Kindler in recent months, another person close to the Pfizer board says. James Kilts, a former Gillette Co. CEO and relatively new Pfizer director, told Mr. Kindler he should ignore such criticism and keep running the drug maker as he sees fit, this person says.

"Meeting with analysts is something I enjoy, even if we don't see eye-to-eye," said Mr. Kindler. "Pfizer has a very clear strategy in place to return shareholder value, and our job at this time is to stay focused on flawless execution. rather than play into market speculation."

Pharmaceutical companies like Pfizer have long exploited tax laws that let them register intellectual property for medicines in foreign countries with lower tax rates, says Gary McGill, an international tax expert at the University of Florida. The maneuver enables them to avoid the U.S.'s 35% corporate-tax rate on much of their profits. Last year, Pfizer's adjusted tax rate was just 21%.

The rub is that Pfizer's dividend has to be paid in dollars from cash held in the U.S., and its U.S. cash position is strained. Morgan Stanley pharmaceuticals analyst Jami Rubin estimates that more than three-quarters of Pfizer's cash pile is overseas, a number Pfizer won't confirm. Moreover, Pfizer's U.S. cash holdings probably dipped into the red last year, when the company spent $10 billion buying back shares on top of the $8 billion spent on the dividend, Ms. Rubin says.

In a sign that Pfizer may be struggling with a cash crunch domestically, the company suspended its share buybacks in the first quarter and borrowed more money, raising its short-term debt to $8.9 billion at the end of March from $5.8 billion at the end of last year. Mr. D'Amelio said that it didn't buy back shares in the first quarter because it wanted to use its money elsewhere, and that the debt increase was due in part to foreign-exchange rates.

Pfizer said it launched a big buyback last year in part because it was flush with money from selling its consumer business for $16 billion.

Pfizer's U.S. cash position is likely to worsen once Lipitor, its best-selling drug, goes off patent, followed shortly thereafter by erectile-dysfunction drug Viagra. Catherine Arnold, a pharmaceutical analyst at Credit Suisse, estimates that Pfizer relies on Lipitor for 65% of its cash flow.

"The dividend is really important to me," says Kent Croft, president of investment manager Croft Leominster, which owns 210,000 Pfizer shares. "The company feels they can keep it up through the patent expirations, but it seems like it's going to be difficult."

The people close to Pfizer's board say it is monitoring the dividend issue closely and continues to have faith in Mr. Kindler. However, some board members aren't convinced Pfizer will be able to fund the dividend without repatriating some of its overseas cash.

Without a faster pace of new-product introduction, "you have to repatriate," one of the people close to the board says. "There comes a time when that gets very, very expensive."

Mr. D'Amelio, the Pfizer chief financial officer, declined to say whether the company's U.S. cash position was low, but said it doesn't matter because Pfizer has enough total cash to pay the dividend, repatriate money or borrow.

He expressed confidence that Pfizer would be able to avoid any blow to earnings through strategic tax planning and by executing on Mr. Kindler's plan to raise cash and reduce costs. If, hypothetically, Pfizer were forced to repatriate some cash and that raised its tax rate to around 28%, Mr. Kindler said, that would take just a 15-cent-a-share bite out of 2012 earnings. "Is it significant? Sure. Is it huge or horrific? No."
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