The Health Care M&A Monthly: A New Round of Consolidation In The Pharmaceutical Sector?

Rumors of mega-consolidations in the Pharmaceutical sector have cropped up during the past month. A number of forces may be cited behind this speculation. One of the more timely reasons for consolidation, actual or proposed, is the need to spread the high costs of drug development, particularly when, under external pressures, multinational companies are committing to sell HIV drugs and other critical medications in Africa and elsewhere at a deep discount. Even though the manufacture and distribution of existing drugs can be relatively cheap, drug discovery itself is not.
But even without such a stimulus to act, consolidation will continue for more obvious reasons. Among the most basic is the desire to capture ever-larger market share to bolster the revenue streams and satisfy investors’ demands.
Pharmaceutical companies, in particular, may be faced with aging products and the imminent expiration of certain patents. Accordingly, they will need to acquire fresh drug development products and pipelines in order to offset the loss in revenue as specialty branded prescription drugs become generics and generics become OTC preparations.
Over the past two weeks, we have heard rumors that Merck & Co. (NYSE: MRK) had offered to buy Schering-Plough (NYSE: SGP) at $65 a share, or a total of $91 billion. That offer amounts to a price to revenue multiple of approximately 10.0x, based on SGP’s annualized first quarter 2001 revenue. However, the source of that rumor, an investment banker "close to the industry," also indicated that SGP had rebuffed MRK’s marriage proposal.
While not as large as Pfizer’s (NYSE: PFE) $111 billion acquisition of Warner-Lambert in the first quarter of 2000, this deal would knock out of second place the $69.9 billion merger in the fourth quarter of 2000 of Glaxo Wellcome PLC and SmithKline Beecham PLC into GlaxoSmithKline (NYSE: GSK).
SGP might want to revisit MRK’s proposal, though. The stock has never broken the $60 ceiling, and it seems unlikely to do so in the near term. The company hit a rough patch this past February when its stock plunged from $56 to $37 on news that the FDA had issued a warning letter over quality control issues at two of its plants.
Nor is it clear that SGP will be able to comfortably weather these and other problems. More recently, the FDA has proposed that the allergy medication Claritin, which accounts for 31% of SGP’s revenue, should be sold over the counter, not by prescription. SGP will fight this move, which has already depressed its share price and could exert downward pressure on its revenues. But it will just be delaying the inevitable: in any event, Claritin’s patent protection is due to expire in 2002-2004.
For its part, MRK appears to be moving ahead in the M&A market. In a more modest yet deliberate move, the company recently announced it would buy Rosetta Inpharmatics (NASDAQ: RSTA), an informational genomics company. Based in Kirkland, Washington, Rosetta makes tools and software that are used in analyzing genetic information in order to identify gene functions and drug targets. For the quarter ended March 31, 2001, RSTA lost $6 million on revenue of $4.7 million.
Under terms of the deal, each of RSTA's 32.2 million shares of stock is to be converted into 0.2352 shares of MRK common stock. At current prices, this works out to a total purchase price of $620 million.
In acquiring RSTA, MRK is seeking to bring in house a drug discovery company along with its technology. In the past, many pharmaceutical companies preferred to outsource this function because of the relative novelty and diversity of genomic testing protocols. MRK is paying handsomely for RSTA. The price to revenue multiple works out to a lofty 32.6x, and the conversion ratio offers an 80% premium over RSTA’s stock price the day before MRK made the announcement.
MRK is not alone in its plans to vertically integrate the drug discovery and development process. In a similar step to beef up its drug discovery capabilities, Vertex Pharmaceuticals (NASDAQ: VRTX) announced this month that it is buying Aurora Biosciences Corp. (NASDAQ: ABSC) in a stock-for-stock exchange. VRTX will issue 0.62 shares of its stock for each share of ABSC common stock, for a transaction value of $592 million.
As a company engaged in the discovery and commercialization of small molecule drugs, VRTX needs access to technologies that enhance the drug discovery process, a need that ABSC’s high-speed assay technology promises to fulfil. This deal is not as pricey as MRK’s deal above: the price to revenue multiple is 8.5x, and the deal offers a 44% premium above ABSC’s prior-day stock price.