Schering-Merck Inching Forward

On Friday, shareholders of Merck & Co. (MRK - Analyst Report) and Schering-Plough Corp. (SGP) gave their nod of approval to the proposed merger of the two drugmakers. The deal, scheduled to close in the fourth quarter of this year, was approved by 99% of voters from each company.

The merger still has to be approved by regulators in the U.S. and other countries before it becomes operational. The $41.1 billion deal will be paid for with a combination of cash and stock.

As a reminder, the two companies entered into the merger agreement in March 2009. Schering-Plough shareholders will receive 0.5767 Merck shares and $10.50 for each stock they own. The companies expect the deal to produce $3.5 billion in annual cost savings as 15% of the combined workforce would be shown the door. The merger is likely to be slightly accretive to earnings in the first year and significantly henceforth.

Merck and Schering-Plough have been long-time partners on cholesterol drugs Vytorin and Zetia, as well as collaborators in respiratory and other disease areas. Other than cholesterol, Schering has a large presence in respiratory therapeutics (Clarinex/OTC, Claritin, Nasonex) and animal health businesses with a large consumer base.

Temodar is Schering's leading oncology drug, an area in which Merck recently began devoting resources, expecting it to be a strong growth driver. Schering also has ex-US rights to Johnson & Johnson's (JNJ - Analyst Report) blockbuster arthritis drug Remicade and its follow-on compound Golimumab.

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

The deal should also help in geographic diversification of revenue sources as Schering currently generates 69% of its revenue overseas, while this figure is only 44% for Merck. The combined entity will have roughly 53% of sales coming from outside the U.S.

The combined company will have a more diverse portfolio across important therapeutic areas, including cardiovascular, respiratory, oncology, neuroscience, infectious disease, immunology and women’s health. The merger will also bring top-selling products under one umbrella.

We believe Merck needs Schering-Plough to help offset concerns of shrinking revenue due to near-term patent cliffs and softening sales of Singulair and Gardasil. Schering has relatively little exposure to patent cliffs through 2013. The combined company will have about 21% of forecasted 2012 revenue exposed to patent expirations.

Shareholders’ approval of the merger sent Merck shares up by 74 cents to $30.10 at close, while Schering-Plough closed at $26.62 after rising by 57 cents.

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