Merck & SGP Announce Merger

Merck and Shering-Plough Announce Merger Agreement

This morning Merck & Co. (MRK - Analyst Report) announced plans to purchase Schering-Plough Corp. (SGP) for about $41.1 billion. The proposed purchase price equates to about $23.61 per Schering-Plough share, a 34% premium over Friday's closing price.

The deal, which is being called a reverse-merger (as Schering-Plough will be the surviving entity), will be paid for with a combination of cash and stock. Schering-Plough shareholders will receive 0.5767 Merck shares and $10.50 for each Schering-Plough common share. Merck expects to fund the cash portion with $9.8 billion cash-on-hand and $8.5 billion in short-term financing ($3 billion 364-day bridge loan and $5.5 billion in revolving debt). The deal is expected to close in the 4th quarter of this year.

The companies expect the deal to produce $3.5 billion in annual cost savings and to be slightly accretive to non-GAAP EPS in the first-full year and significantly accretive afterwards. Merck and Schering posted sales of $23.9 billion and $18.5 billion, respectively, in 2008. We forecast combined sales to be $44.1 billion in 2010 and $45.4 billion by 2012. Merck expects non-GAAP EPS to grow at a CAGR [compound annual growth rate] in the high-single digits from 2009 through 2013. The dividend, currently paying $1.52 is expected to be maintained following the deal close.

Merck is faced with significant patent cliffs over the next 4 years while Schering-Plough has very little exposure to patent expirations. The proposed deal is clearly an attempt to address Merck's patent issues. Patents on Merck's Cozaar and Singulair will expire in February 2010 and August 2012, respectively, exposing about $8.2 billion worth of sales to generic competition. This equates to about 35% of Merck's forecasted revenue in 2012.

By contrast, Schering only has about 6% of its forecasted 2012 revenue exposed to patent expirations. The combined company will have about 21% of forecasted 2012 revenues exposed to patent expirations.

Merck and Schering-Plough have been long-time partners on cholesterol drugs Vytorin and Zetia, and have also collaborated in respiratory and other disease areas. The merger should offer little overlap in currently marketed products and pipeline compounds. Other than cholesterol, Schering has a large presence in respiratory therapeutics (Clarinex/OTC, Claritin, Nasonex) and has large consumer and animal health businesses.

Temodar is Schering's leading oncology drug, an area which Merck recently began allocating more resources toward and one which the company believes will be a strong driver of growth. Schering also has ex-U.S. rights to Johnson & Johnson's (JNJ - Analyst Report) blockbuster arthritis drug Remicade as well as its follow-on compound golimumab, currently under regulatory review in Europe.

Schering's pipeline, considered one of the strongest in all of big-pharma, contains very promising compounds in arthritis, asthma, hepatitis-C, and cardiovascular disease.

Outside of cholesterol, Merck's product portfolio is heavily weighted towards respiratory (Singulair), diabetes (Januvia) and vaccines (Gardasil). Merck's late-stage pipeline includes candidates for cardiovascular disease, cancer, asthma, and osteoporosis.

Overall, we believe there will be little product overlap, and expect the combination to provide significant synergistic opportunities with combining sales, marketing, research and other back-office functions.

The deal will also provide Merck with greater geographical reach. Schering has a significant presence in international markets with about 70% of revenues coming from overseas, versus only 44% for Merck. The combined entity will have roughly 53% of the sales coming from outside the U.S.