Merck succumbs to urge to mega-merge

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Since Pfizer made a somewhat desperate move in January to try and retain its number one ranking as the industry’s biggest pharmaceutical company by acquiring Wyeth for $68bn (Pfizer’s desperate move on Wyeth, January 26, 2009), the fear has been that this would trigger a new wave of mega-merger consolidation; good news for banks, consultants and lawyers but ultimately bad news for shareholders as short-term cost savings rarely translate into long-term value.

Today’s revelation that Merck & Co is acquiring Schering-Plough for $41.1bn at a 34% premium, through a complicated “reverse-merger” deal designed to try and retain rights to key products, indicates a new mega-merger wave is upon us. Whilst Pfizer’s move for Wyeth was not surprising given its mega-merger history, Merck’s bid for Schering marks a significant change in strategy. Previously the group’s biggest company acquisition was a $1.1bn swoop on Sirna Therapeutics in 2006, suggesting the industry’s patent cliff is causing desperate companies to adopt desperate measures.

Climbing the league

In terms of the global league table for pharmaceutical sales, the Merck-Schering tie up would certainly propel both companies up the rankings, with combined sales in 2008 of $41.3bn set to grow 2% annually to $45.3bn by 2014. This ranks the new company in third position, behind the Pfizer+Wyeth merged company and Roche.

The table below, which uses EvaluatePharma’s merge companies tool to create a virtual merged company, Merck+Schering-Plough, shows the top ten companies by pharmaceutical sales in 2014 and reflects a rapidly changing landscape for the industry’s leading companies.

WW pharmaceutical rankings in 2014 Prescription (Rx) sales ($m) Market Share Market Rank
2008 2014 CAGR (08 - 14) 2008 2014 2008 2014
Pfizer+Wyeth 57,682 48,200 (3%) 9.4% 6.6% 1 1
  Roche 33,277 47,721 6% 5.4% 6.5% 6 2
Merck+Schering-Plough 41,296 45,284 2% 6.7% 6.2% 3 3
  Novartis 34,462 45,074 5% 5.6% 6.1% 5 4
  Sanofi-Aventis 41,444 37,128 (2%) 6.7% 5.0% 2 5
  GlaxoSmithKline 36,890 33,180 (2%) 6.0% 4.5% 4 6
  Pfizer 41,923 29,344 (6%) 6.8% 4.0% - -
  Johnson & Johnson 23,510 25,880 2% 3.8% 3.5% 8 7
  Merck & Co 25,256 25,537 0% 4.1% 3.5% - -
  Abbott Laboratories 17,174 22,672 5% 2.8% 3.1% 10 8
  AstraZeneca 30,264 21,806 (5%) 4.9% 3.0% 7 9
  Schering-Plough 16,040 19,747 4% 2.6% 2.7% - -
  Wyeth 15,759 18,857 3% 2.6% 2.6% - -
  Teva Pharmaceutical Industries 9,538 18,848 12% 1.6% 2.6% 16 10

Although a slight aside, perhaps one of the most intriguing aspects of this changing landscape is the appearance in this top ten league of the world’s leading generics company, Teva Pharmaceutical Industries.

Reverse merger trend

Although there is a recent trend for increasing numbers of reverse mergers, these normally involve a small-sized private company backing into a distressed public company.

The reverse merger terms of this deal, with Schering-Plough effectively the surviving entity but Merck’s shareholders controlling 68% of the combined company, was therefore something of a surprise.

The rationale for such a complicated move appears to be designed to avoid triggering a change of control clause over Schering’s key rheumatoid arthritis antibodies, Remicade and golimumab, licensed from Johnson & Johnson’s biotech subsidiary Centocor.

Schering holds commercialisation rights to both products outside the US. Remicade was Schering’s biggest selling drug last year with sales of $2.1bn and is the group’s most valuable product with an NPV of $4.58bn, according to EvaluatePharma’s NPV Analyzer.

Meanwhile, golimumab, currently under review in both the US and Europe and with a proposed trade name of Simponi, is Schering’s biggest revenue growth driver over the next six years, with international sales of $902m by 2014.

With so much riding on the value of these products, the company was keen to stress it believes the merger structure is such that on a technical level Schering is still the surviving company.

Whether J&J will accept such an argument remains to be seen and it can be assumed they will be looking closely at the terms and conditions of the original license and assessing whether they want to pursue legal avenues to try and acquire both products outright.

Patent cliff bites

Whilst most big pharma companies are still facing a precipitous patent cliff, Merck is already sliding rapidly down its own.

The group’s top three biggest-selling products in 2007, Singulair, Cozaar and Fosamax with combined sales of $10.7bn, are all set to be exposed to generic competition by 2012. Fosamax’s patent expired last year, Cozaar goes generic in 2010 and Singulair’s patent, currently being challenged by Teva (Merck set for Singulair patent battle, February 16, 2009) will expire in 2012, or earlier if Teva prevails or a compromise is reached.

In a similar vein to Pfizer, which prior to the Wyeth deal talked up the prospects of smaller, more manageable acquisitions to drive long-term growth, it appears Merck’s current situation has also caused a change of heart, having previously made strong noises about seeking medium-sized acquisitions (Who might be on Merck's shopping list?,May 2, 2008).

Right transaction, right time

A consistent message from the company’s conference call, particularly from Schering’s chief executive officer, Fred Hassan, who previously sold Pharmacia to Pfizer in 2003, was of this tie up between Merck and Schering being the “right transaction, at the right time”.

Both companies have been severely hit by the decline in current sales and prospects for two lipid-lowering agents, Vytorin and Zetia, the commercialisation of which is conducted by their joint venture, Merck/Schering-Plough JV.

Schering’s market capitalisation, before this deal, of $28.7bn is significantly lower than the sum of the group’s NPV of marketed products at $36.9bn.

Although Merck’s offer of $23.61 per share, split 44% in cash and 56% in stock, is a 34% premium to Schering’s share price of $17.63 on March 6, compared to the valuation of the group’s future cash flows even just for marketed products, the premium is a lot lower at 11%. Merck is therefore virtually getting Schering’s pipeline, currently valued at $11.5bn, for free.

Despite the potential bargain of this deal, Merck’s shareholders seem unimpressed, sending shares in the group down 10% today to $20.59, a 14-year low. It therefore appears shareholders are subscribing to the view that these mega-mergers tend only to erode value and have not been swayed by the cost-saving and synergy arguments put forward by senior management of both companies.

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