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Merck (MRK)
Merck Buying More Drugs
These past few days, Merck and Schering-Plough (SGP: Charts, News, Offers) agreed to an acquisition arrangement where the former would buy out its rival for $41.1 billion. This represents a 34 percent premium from Friday's closing price. Current Schering-Plough shareholders will receive 0.5767 shares, plus an additional $10.50 for every share that they own. While this is mostly a cash-and-stock deal, Merck is taking in $8.5 billion in debt. The result would give Merck a 68 percent interest in the target company. Unlike other M&As in the industry, this agreement was reached quickly and with little strife. It seems both companies wanted this to go through. When all is said and done, however, does this acquistion really make sense?
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Yes, it certainly does. Patents on blockbuster drugs are reaching the end of their protected status, and the two New Jersey-based companies must find alternatives to continue funding their costly research and development operations. With an acquistion, they get the benefits of lower R&D costs and a consolidated research division. They should also achieve increased profit margins resulting from shared profits of existing blockbuster drugs. The more diversified portfolios will help the two as they struggle to push new products to market amid more regulatory pressure from the federal government. One other benefit is a result of this recession. M&A costs are lower right now than they would be in a bull market. Around the beginning of August, shares of Schering-Plough were being traded for a little over $19. If an arrangement had been made at that time with the same 34 percent premium, the deal could easily have been worth more than $55 billion dollars.
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One could argue that this deal comes from necessity. Unlike Johnson & Johnson (JNJ: Charts, News, Offers), the two companies have a less diversified product portfolio. For example, they do not manufacture many consumer drugs nor do they produce medical instruments. This may have resulted in relatively lower fixed costs for many years, but it has proven ineffective in weathering the economic crisis.
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Analysts are saying this acquisition is not for the purposes of drug discovery, but one of necessity. It will be done mostly for the cost benefits. Proof comes from the 15,000 jobs that will be cut. As operations become more consolidated, the need for multiple workers with the same job function diminishes. This could be a problem as more M&A agreements may be announced, as the health industry was one of two areas in the economy that still need talented workers and employees.
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Another potential problem with the merger comes from the drug Remicade. The rights to this drug are shared with J&J, where they own the domestic rights and Schering-Plough owns the international rights. This drug generated about $2.1 billion or about 11% of the company's annual revenue. Assuming the merger agreement is approved by the FTC, J&J can seek arbitration be the sole owner of the drug. Lawyers for Merck and its target have thus strcutured the deal such that Schering-Plough would be the surviving corporation, even though it will continue to be called Merck.
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First, it was Wyeth (WYE: Charts, News, Offers) and Pfizer (PFE: Charts, News, Offers), then it was Genentech (DNA: Charts, News, Offers) and Roche. Now, it is Merck and Schering-Plough. Should we expect more mergers to come about from the health industry? More than likely, yes. AstraZeneca (AZN: Charts, News, Offers) might be on the list to merge sometime in the near future, as their situation is similar to that of the aforementioned companies. In fact, many of their blockbusters are already facing competition from their generic alternatives. For now, Merck and Schering-Plough are just getting started and investors too should focus on the two drug giants as they work their way through this deal.
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