Monday, March 9, 2009

Combination Product: Merck Throws Lifeline to Bankers Via Reverse Merger with Schering-Plough

In a somewhat strange maneuver, Schering-Plough Corp. ("SGP") will be renamed Merck & Co. ("MRK") and SGP shareholders will receive cash plus the equivalent of current Merck shares. The current Merck board and senior management will run the combined company, so this is in effect a Merck takeover of SGP.

Merck obviously noticed that from the time Pfizer announced its acquisition of Wyeth, Pfizer stock has fallen more than the Dow, from close to $18/share to close to $13/share.

(Econblog Review reported on that deal in Pfizer Buys Wyeth: Layoffs Financed by You and Me.)

Everyone in the pharmaceutical industry knows that there are no benefits to shareholders from two giant companies merging with or acquiring each other. Also, every investment banker and knowledgeable businessperson knows that acquisitions in general do not benefit shareholders of the acquiring company. (An exception may be the major acquisition that SGP itself performed a couple of years ago, which bulked it up and thus may have made SGP more attractive to Merck.)

Why, then, is this happening? lets the cat out of the bag in "Merck to Buy Schering-Plough for $41 Billion (Update3)":

“The price seems way too low,” said David Moskowitz, an analyst with Caris & Co, in a telephone interview today. “It’s a tremendous deal for Merck. Every bank in the world should want to line up and fund this deal at this price.

(JPMorgan Chase is going to provide $8.5 billion in committed financing.)

So, this is about an attractive deal for bank financiers. Is it a good deal for Merck shareholders, or are they to be the bagholders?

From the relevant Merck press release:

Accretive to Earnings: The transaction is anticipated to be modestly accretive to non-GAAP EPS¹ in the first full year following completion and significantly accretive thereafter.

Here is the relevant footnote, which Merck does not want anyone to read or think about:

¹. Excludes purchase-accounting adjustments, restructuring costs, acquisition-related costs and certain other significant items.

I don't know about you, but as a simple-minded soul, I prefer to trust Generally Accepted Accounting Principles and would have reversed the presentation. I would have highlighted GAAP earnings projections, delineated the expected cash costs etc., and perhaps mentioned certain non-GAAP ways of thinking of the bounteous rewards of this deal in a footnote.

From the Merck PR:

Merck is targeting a high single digit non-GAAP EPS1 compound annual growth rate from 2009 (2009 base represents Merck's stand alone non-GAAP EPS guidance) to 2013. Additionally, in 2013, Merck is targeting pretax margins¹ to be nearly 40 percent and free cash flow to be approximately $15 billion. In light of the announced transaction, Merck today provided 2013 guidance that supersedes previously provided 2010 stand-alone guidance.

This is strange at best. We are living through a recession/depression where even food sales are suffering and where electric bills are going unpaid; and we have a new President who is or may well soon be rattling the cage of all profit-making medical companies. So Merck, which really doesn't know how much of anything it will sell next quarter, guides through 2013?

Now, let's briefly discuss the business merits of this particular transaction. Merck and SGP partner in marketing SGP's Zetia and the Zetia plus Zocor (Merck product) combination product called Vytorin. This once was a hot one-two punch, but about a year ago, the companies were forced to come clean by finally releasing data on a failed study of Zetia, which showed it was useless when added to Zocor in preventing plaque formation in the carotid arteries. The European lead investigator of this study issued a cri du coeur claiming a corporate cover-up and bad behavior; some Congressmen made noises, and, per Bloomberg:

As of Jan. 31, U.S. sales of Vytorin slid 43 percent and Zetia 33 percent since a January 2008 study questioned whether the drugs were better at unclogging arteries than an older generic pill (i.e., Zocor, now available generically).

So there's not much going on with that franchise that would now excite Merck to control it.

One wonders if either company is undergoing a growth spurt that would benefit from an underutilized sales force. Here is Bloomberg's comments on each company:

Merck Chief Executive Richard Clark has said he was looking for acquisitions after failing to win U.S. regulatory approval for cholesterol pill Cordaptive and declining sales of the Gardasil cervical cancer vaccine. Whitehouse Station, New Jersey-based Merck said in October it would cut 7,200 jobs and close plants in 2009 as it braces for generic competition to $8 billion in products within five years.

Schering-Plough Chief Executive Officer Fred Hassan has been firing workers and closing factories to save $1.25 billion by 2010 to recoup some of the cholesterol pill losses.

As with the Pfizer-Wyeth deal, we see two shrinking giants, each past their prime, doing their part to keep the finance-based economy humming. And presumably much of the deal is being financed with TARP and AIG bailout money that the banks will now recycle into what they hope will be a predictable stream of interest payments.

There is some sadness to this veteran of the pharmaceutical industry in reporting on this particular deal. I seem to recall that for three years running in the 1990s, Merck, under the marvelous physician-CEO Roy Vagelos, was rated the most admired U.S. company. Merck had a passel of truly innovative, science-based, internally discovered or internally developed drug products. Post-Vagelos, it was all downhill, including their misbehavior in over-promoting Vioxx and then the embarrassment when they and SGP withheld the Zetia/Zocor carotid data for about a year. Most-admired no more.

Merck & Co., which was formed during World War I when the parent, a German company, was forced to divest its U.S. operations, is now going to cease corporate operations. It was a great company which has contributed mightily to the improvement of human health. Like so much of corporate America, it lost its way the past decade. Let us hope that Schering-Plough, which will carry on the Merck name under Merck management, will channel the best of Merck's past and dedicate itself not to doing deal after deal or promotion of non-GAAP earnings numbers but to serving mankind by developing important medications.

Unfortunately, hope is not an investment strategy (just as it is not a viable strategy for the Secretary of the Treasury and his boss), and I would be just as skeptical of the investment merits of this deal as I was of the Pfizer-Wyeth deal.

Copyright (C) Long Lake LLC 2009

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