Merck’s Maneuvers

Merck, an American drugmaker, has agreed to pay $41 billion for a rival, Schering-Plough.
Economist StaffMarch 10, 2009

The language was reminiscent of a happier time before the credit crunch and brewing economic devastation closed the book on most such mergers. Merck’s boss, Dick Clark, called the agreed deal to acquire Schering-Plough, which was announced on Monday March 9th, a “transformational event.” He then expounded on the “strategic sense and … exceptional promise” on offer. Fred Hassan, boss of the rival American pharmaceutical giant, perhaps mindful of appearing triumphalist as the world wobbles, chipped in with a more sober vision of a “leading company” that will be “well positioned.”

Perhaps Mr. Clark could be forgiven his exuberance. The deal is a (mostly) bright spot amid a global corporate landscape of bankruptcy and retrenchment. Merck will pay $41 billion for Schering-Plough, with the total made up partly of shares, $9.8 billion from cash reserves and another $8.5 billion prised from the clutches of a bank, JPMorgan. Although credit has dried up almost everywhere else, drug companies, with their cash reserves and healthy revenues, can still call on the banks. Last month Pfizer, another American drug company, was able to count on bank loans to assist in its $68 billion acquisition of Wyeth. 

Big drug firms are also keen to consolidate as a way of heading off gathering problems. On Friday Switzerland’s Roche raised its offer for the 44 percent of Genentech, an American biotech firm, that it does not already own. Sanofi-Aventis of France is also said to be on the acquisition trail. Buying rivals is one way for drug companies to boost anaemic product pipelines, under assault from expiring patents on blockbuster medicines and generic competitors. Merck’s asthma medicine, which gives it a sixth of its revenues, loses patent protection in the next few years. In one swoop Merck will double — to 18 — the number of drugs it has in the later stages of development.

Drug companies are also gearing up for a reform of American healthcare. Precisely what will transpire is unclear, but it seems likely that government health schemes will demand bigger discounts from drug suppliers. Added to this is the worry that cash-strapped American consumers (the biggest single market for drugmakers) who lack insurance or who face high bills before insurance kicks in, are cutting back on spending. However Schering-Plough derives 70 percent of its revenues outside of America, which should spread risk. The deal will also give Merck greater access to foreign drug markets: half of the new firm’s revenues will come from beyond America’s shores.

The deal should afford the opportunity to cut costs. Mr. Clark said that 15 percent of the combined firm’s 106,000 employees would lose their jobs. In addition to existing rounds of cost-cutting by both firms, Merck expects to make another $3.5 billion in annual savings after 2011. One difficulty for Merck is that the deal might jeopardise Schering-Plough’s co-marketing agreement with Johnson & Johnson for Remicade, a money-spinning anti-inflammatory drug. But Mr. Clark is confident the structure of the deal should guard against this.

The deal goes some way to answering critics who complained that Merck was not acting as vigorously as competitors in buying rivals and moving into new markets. The challenge for Mr. Clark, who will become boss of the new company, is to show that, despite a lack of experience, he can see through the big deal smoothly. Mr. Clark has done a fine job of steering the firm out of the crisis caused by the safety scandal surrounding Vioxx, its blockbuster painkiller. But Merck, unlike many of its peers, has never before attempted a mega-merger of this sort: the company has preferred to grow by developing new products in it own laboratories. Mr. Hassan is getting out because he fears that the macroeconomic conditions are growing more difficult for drug firms. Mr. Clark must hope that the deal will help Merck to weather the storm.