The Health Care M&A Monthly: Merck Buys Schering-Plough--
$44.1 Billion Deal Makes Merck Number Two U.S. Pharma
Big pharma produced not one, but two mega-deals during the first quarter of 2009. In the most recent one, Merck & Co. (NYSE: MRK) announced that it is paying approximately $44.1 billion to buy rival Schering-Plough Corporation (NYSE: SGP). When consummated, the union of these two New Jersey-based firms will make Merck the second largest pharma company in the country with $42.0 billion in annual sales.
Based in Kenilworth, New Jersey, Schering-Plough operates in three large segments: prescription pharmaceuticals, consumer health care and animal health. In particular, prescription pharmaceuticals offers drugs in six therapeutic areas: cardiovascular, central nervous system, immunology and infectious disease, oncology, respiratory, and women’s health. On a trailing 12-month basis, SGP generated revenue of $18.5 billion, EBITDA of $3.0 billion and net income of $1.8 billion.
Schering-Plough, it may be recalled, was sailing through dire financial straits not so long ago. The company had been caught off guard in 2002 and 2003 when its blockbuster allergy drug Claritin lost patent protection and faced government probes. In 2003, Fred Hassan was brought in to turn the company around. Mr. Hassan had been in upper management at Wyeth (NYSE: WYE) in the 1990s and then became CEO of Pharmacia. During his tenure there, he negotiated the $37.0 billion takeover of Monsanto to gain its Celebrex arthritis drug, the spin-off of Monsanto’s animal health business and, pièce de resistance, the $56.0 billion sale of Pharmacia to Pfizer. Once ensconced at Schering-Plough, he nursed it back to financial health and masterminded the $15.8 billion acquisition of Organon BioSciences, along with its CNS and reproductive medicine drugs, from Akzo Nobel to diversify SGP away from its dependence on cholesterol drugs. Recently, SGP’s flagship cholesterol drugs Vytorin and Zetia have seen sales fall off, along with the company’s ability to fund its late-stage research projects. To avoid being caught in the trap that ensnared SGP earlier with Claritin, Mr. Hassan decided to seek out a merger partner. One reason to pursue a deal with MRK is that SGP’s Vytorin combines its own Zetia with Merck’s Zocor.
Like Schering, Merck & Co., based in Whitehouse Station, New Jersey, also provides pharmaceutical products for humans and animals. On a trailing 12-month basis, MRK generated revenue of $24.0 billion, EBITDA of $8.0 billion and net income of $7.8 billion. However, MRK has been looking for acquisitions after failing to gain U.S. regulatory clearance for its Cordaptive cholesterol pill and declining sales of its Gardasil cervical cancer vaccine, as well as the looming patent expiration of its Singulair asthma drug in 2012.
This combination would create a company with two cholesterol drugs, MRK’s Zetia and SGP’s Vytorin, both of which compete with Pfizer’s blockbuster Lipitor. It is estimated that the deal will generate savings of $3.5 billion each year after 2011. It would also double the size of MRK’s late-stage pipeline to include experimental drugs in the cardiovascular, infectious disease, neuroscience, oncology and respiratory areas. It would further broaden the sources of MRK’s revenue; currently, 70% of SGP’s revenue comes from outside the country. And, as noted by Jefferies analyst Jeffrey Holford, this merger responds to overcapacity in the current market for branded pharmaceuticals by taking out each other’s (over)capacity.
Under terms of the agreement, SGP shareholders are to receive 0.5767 shares of MRK common stock and $10.50 in cash for each share of SGP common they own, based on the trailing 30-day volume-weighted average price of MRK stock at $27.3109. This transaction values each share of SGP at $26.25 and thus offers SGP shareholders a 34% premium to the stock’s prior-day price and a 44% premium to the average closing price of the two stocks over the prior 30 trading days. The deal is being financed with $9.8 billion in cash, $8.5 billion in debt from JPMorgan Chase & Co. and $22.8 billion in MRK stock. After the dust settles, current MRK shareholders will hold 68% of the combined company; current SGP shareholders, 32%.
The deal is being structured as a reverse merger, with SGP as the surviving company taking on the MRK name but retaining MRK’s CEO Richard Clark, in order to smooth out what could be a stumbling block to the combination. SGP has a marketing agreement with Johnson & Johnson (NYSE: JNJ) for the anti-inflammatory drug Remicade, and could lose control of the drug if there were to be a change in control at SGP. Whether such a legal tactic will mollify JNJ—it will almost certainly not—remains to be seen, and SGP may have to negotiate the international rights to Remicade at a fair price. This merger may also be vulnerable to anticompetitive concerns, particularly in the area of animal health. If past is prologue, some portion of the animal health segment could be sold off to appease authorities and to focus on human pharmaceuticals.
The acquisition multiples are 2.3x revenue and 12.5x EBITDA. On the face of it, the P/R multiple suggests that the economic downturn has worked its way into pricing for pharmaceutical companies. Comparison of this multiple and the 2.9x multiple in January’s Pfizer-Wyeth $68.0 billion deal with multiples in prior years would indicate that pricing has indeed slumped. The chart above shows the average and median P/R multiples for billion-dollar pharma deals from 2002 through 2008. For the past five years, the median price has hovered around 3.6x. However, what we don’t clearly know yet is whether the deal’s 2.3x multiple reflects an actual change in market pricing, whether it has built in the possible loss of value due to the potential brouhaha over Remicade and SGP’s animal health unit, or whether a low multiple was intended to entice bankers to finance the deal. We’ll have a better grasp as further details emerge.
Analysts noted in the day or two following the original announcement that the stock market did not appear to react to what would have been bullish news in other times and other markets. However, the lagging effect noted in our cover story may be at play here. The four weeks following the announcement saw the DJIA rise week over week.
JPMorgan provided MRK with financial advice on this deal; Goldman Sachs provided SGP with similar advice. As we were going to press, MRK and JPMorgan had already completed the primary syndication of $7.0 billion of a new MRK credit facility with commitments from eight additional co-arrangers: Bank of America, BNP Paribas, Citi, Credit Suisse, HSBC, The Royal Bank of Scotland plc, Santader and UBS.
Finally, we somehow doubt that even after helping to shepherd his company through the merger, Schering-Plough’s Mr. Hassan will want to ease himself into retirement. He readily admits that he is a workaholic and has no major hobbies, so he will be available to head up another company.