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Pfizer drives a hard bargain

Monday - 4/23/2012, 4:38pm  ET

Who knew baby formula was so desirable in emerging markets? Pfizer reportedly got Nestle (OTC: NSRGY) and Danone into a bidding war over its nutrition business, driving the price up to $11.85 billion.

Nestle won. Danone lost. But the losers would also seem to include Abbott Labs and Mead Johnson Nutrition , which will continue competing with the SMA Gold brand that now has a highly motivated owner looking for high growth to justify the high purchase price.

For Pfizer, it looks like a solid deal. We already knew the pharmaceutical giant was going to unload the nutrition business; the only question was how. An IPO like Bristol-Myers Squibb did to divest of Mead Johnson seemed like a good option, but with multiple bidders, Pfizer appears to have made the best choice to maximize value. Nestle will be able to achieve some synergies that a stand-alone company wouldn't, which helps it justify a higher price than Pfizer would likely have gotten in an IPO.

Pfizer plans to repurchase shares or "invest in other business-development opportunities" with the proceeds of the deal, which is expected to close in the middle of next year. The math works for repurchasing shares.

Earnings before interest, tax, depreciation, and amortization for the division were reportedly about $600 million. If we apply Pfizer's tax rate of 20% of operating income, the sale would knock $480 million off its 2011 earnings -- likely substantially less, as depreciation and amortization of expenses would lower that further. To keep the same earnings per share in this worst-case scenario, Pfizer would have to repurchase 374 million shares at the current cost of $8.4 billon. It's hard to know what kind of taxes it'll have to pay on the $12 billion sale, but considering this is a worst-case scenario, it looks like the transaction will help the bottom line if Pfizer uses the proceeds to repurchase shares.

Of course, there's always the option to "invest in other business-development opportunities," which hopefully means buying biotechs or licensing drugs and not another Wyeth-sized acquisition. Pfizer's shares aren't dirt cheap at the moment, and while repurchasing shares does have the added benefit of lowering the cash required for dividends, I have to think there are biotechs out there with potential to add more to earnings in the long term than repurchasing shares.

Of course, Pfizer still has its animal health business to dispose of, so maybe there will be cash for both.

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This article was originally published as Pfizer Drives a Hard Bargainon Fool.com

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