Merck, Schering merge in $41.1B deal

Increasing generic competition and pricing pressures unite two more of the world's largest pharmas

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WHITEHOUSE STATION, N.J.—Increasing generic competition and pricing pressures united two more of the world's largest pharmaceutical players last month, as Merck & Co. announced March 9 that it will buy Schering-Plough Corp. in a $41.1 billion stock-and-cash deal that some industry veterans are calling "the mating of dinosaurs." Merck's announcement was the second mega-deal announced in the pharmaceutical sector in recent months, as Pfizer Inc. announced in January that it is buying Wyeth for $68 billion (see "Pfizer buys Wyeth for $68 billion," DDN February 2009.)

Under the terms of the agreement, Schering-Plough shareholders will receive $23.61 per share, or $41.1 billion in the aggregate, a premium of approximately 34 percent based on the closing price of Schering-Plough stock on March 6. The consideration also represents a nearly 44 percent premium based on the average closing price of the two stocks over the last 30 trading days. The cash portion will be financed with a combination of $9.8 billion from existing cash balances and $8.5 billion from committed financing to be provided by J.P. Morgan. The deal is expected to close in the fourth quarter.

Upon closing of the transaction, Merck shareholders are expected to own approximately 68 percent of the combined company, and Schering-Plough shareholders are expected to own approximately 32 percent. Merck anticipates that the transaction will be modestly accretive to non-GAAP EPS1 in the first full year following completion and significantly accretive thereafter.

The combined company will have a more diverse portfolio across important therapeutic areas, including cardiovascular, respiratory, oncology, neuroscience, infectious disease, immunology, women's health and other areas, said Merck Chairman, President and CEO Richard Clark in a statement.

"We are creating a strong, global healthcare leader built for sustainable growth and success," Clark said. "The efficiencies we gain will allow us to invest in strategic opportunities, while creating meaningful value for shareholders. The combined company will benefit from a formidable research and development pipeline, a significantly broader portfolio of medicines and an expanded presence in key international markets, particularly in high-growth emerging markets."

Schering-Plough generates about 70 percent of its revenue outside the United States, including more than $2 billion from emerging markets. The combined company is expected to draw more than 50 percent of its revenue from outside of the U.S.

The companies, which are already partners in a pair of popular cholesterol fighters, Vytorin and Zetia, "are joining forces … to create a dynamic new leader in the pharmaceutical industry," said Fred Hassan, chairman and CEO of Schering-Plough.

"Over the last six years, Schering-Plough colleagues have transformed our company into a strong competitor in the global pharmaceutical industry," Hassan said in a statement. "We have built a strong, diverse business and a robust pipeline that offers hope to patients who are waiting for new medicines. By harnessing the strengths of both companies, the combined entity will be well-positioned to further deliver on our shared goal of discovering new therapies for patients to help them live healthier, happier lives."

The deal is structured as a reverse merger in an attempt to avoid triggering change-of-control provisions in Schering-Plough's partnership with Johnson & Johnson for two biologic drugs for rheumatoid arthritis, the blockbuster Remicade and golimumab, which is in late-stage testing.

Many in the pharmaceutical industry have questioned whether Johnson & Johnson's partnership with Schering-Plough on the blockbuster anti-inflammatory drug Remicade and its follow-up golimumab will throw a monkey wrench in Merck's planned merger with Schering-Plough.

J&J holds marketing rights in the United States for both drugs, while Schering-Plough holds marketing rights to Remicade outside of the United States, Japan and certain Asian countries. J&J posted $3.7 billion in Remicade sales last year, while Schering-Plough produced revenues of $2.1 billion.

Merck could pick up the two drugs, but a long-standing distribution agreement between Schering and J&J specifies that if Schering-Plough were acquired, J&J would have the right to cancel the agreement and take full control of the drugs and the billions of dollars they generate.

To get around this provision, Merck drew up a reverse merger deal in which Schering-Plough becomes the surviving company, but retains the name of Merck—and will continue to be controlled by current Merck shareholders.

Documents filed with the U.S. Securities & Exchange Commission (SEC) give J&J one month to decide whether it will try to claim back full rights over the two drugs. At press time, J&J had not yet taken action, fueling analyst speculation of a possible bidding war.

Catherine Arnold, pharmaceutical analyst at UBS, says "a bid by J&J can't be ruled out" because of both strategic and financial reasons. Despite the fact that J&J has not entered into any bidding wars with its pharmaceutical competitors and its largest-ever acquisition was its &16.6 billion purchase of Pfizer's consumer healthcare unit in 2006, a move to outbid Merck "would not be impossible," Arnold says, as J&J faces numerous challenges including stiff competition in some of its diverse businesses and a sluggish pipeline in its pharmaceutical division.

Merck said its 2009 outlook has not changed, and it is committed to keeping its annual dividend at its current level of $1.52 per share. Both drugmakers reported better-than-expected quarterly results in early February, but announced steep job cuts.

Both companies said they will institute hiring freezes immediately. Merck spokeswoman Amy Rose told the Associated Press that the deal will not bring any "immediate" changes to staff. Merck and Schering-Plough have about 55,200 and 50,800 employees, respectively. Eventually, the companies "anticipate an approximate 15 percent reduction in the combined company's headcount," Rose said, which would impact nearly 16,000 jobs.

The combined company will have its corporate headquarters in Whitehouse Station, N.J. with Clark at the helm. Hassan said he will participate in planning the integration of the two companies until the close of the deal, but he has not decided what he will do after the merger. Merck's integration team will be led by Adam Schechter, president of Global Pharmaceuticals. Schering-Plough's integration team will be led by Brent Saunders, senior vice president and president of Consumer Health Care.

Following the announcement on March 9, Schering shares jumped 20 percent to $21.14, and Merck shares, after plunging about 8 percent, recovered to $22.28, down 2.1 percent.

Stephen Pope, chief global market strategist at Cantor Fitzgerald Europe, said it is "a constructive deal because Merck recognizes that the level of access to Schering-Plough's pipeline is good."

"Schering-Plough wasn't necessarily in the best position to develop some of these drugs," Pope said. "Overall, it's a very sensible move."

Matthew Herper, senior editor at Forbes, disagreed, calling the deal "another merger of weakness."

"The deal puts a capstone on Merck's proud history, in which it insisted it could survive mainly on its own research," Herper wrote. "In a sense, this is the end of Merck. It also is a clear sign that there is going to be lots of consolidation—and job cuts—in the drug industry. Drug company veterans are calling it 'the mating of dinosaurs.' It does not solve the fundamental problems regarding innovation that have plagued drugmakers, and may be a sign that things are actually getting worse."

The deal did not come as a huge surprise, however, given the pressures faced by the companies' competitors as they face patent expirations of blockbuster drugs in the next few years. Many analysts agreed that because the Merck-Schering merger puts the companies on par with Pfizer and Wyeth, competing pharmas such as Bristol-Myers Squibb and Eli Lilly & Co. may be pressured to merge.

Timo Kuerschner, an analyst with LBBW, told Forbes that although there is more pressure on American pharmas to merge because of their tendency to rely on blockbuster drug revenues, the wave of consolidation may eventually hit Europe. He told Forbes that he expects to see Sanofi-aventis give into patent pressure and choose a partner, possibly a generics company like Ratiopharm.

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