Financing Your Acquisition

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Swallowing a company that's half its size is no small feat for even the most cash-rich companies. Schering-Plough (NYSE: SGP) moved one step closer to financing its $14 billion acquisition of the Organon BioSciences unit of Akzo Nobel (Nasdaq: AKZOY) by making a stock offering last week.

The company announced that it will sell common stock and convertible preferred stock to raise more than $4 billion. The rest of the funds will come from debt and existing cash.

Unlike Mylan Laboratories (NYSE: MYL) which is financing its huge acquisition of the generics unit of Merck KGaA by taking on debt and then planning on making a stock offering after the larger-than-life company is formed, Schering is getting its money out first. It's had a pretty stellar first half of the year, with its stock up more than 20% for the year, so now seems like a pretty good time to make a stock offering.

The addition of Organon BioSciences will add about $5 billion in annual sales to Schering's revenues. Most importantly, the expanded sales will help Schering rely less on its cholesterol drugs Zetia, as well as Vytorin, which combines Zetia and Merck's (NYSE: MRK) Zocor. Sales of those two drugs made up 16% of its revenues last year.

In addition to the existing products, Schering also inherits an extensive pipeline including five drugs in late stage clinical trials. The drugs cover a gamut of diseases from schizophrenia to infertility to insomnia. It also inherits a healthy pipeline including six phase 2 drugs and 10 drugs in phase 1 trials.

Schering is going to need to take some serious cost-cutting measures after the merger to justify the high acquisition price. One place it will probably be able to cut margins is in combining the two companies' animal health divisions. The resulting division will be larger than that of rival Pfizer (NYSE: PFE), which had more than twice as much sales of animal health-related products last year than Schering did.

The acquisition is expected to close by the end of the year, so it will take a while before investors know whether Schering's major acquisition has paid off. Funding part of the acquisition through a stock offering will decrease future interest payments and is an especially good idea with the stock, as potentially overvalued as it is. If Schering can use the same tactics it used to produce 11 quarters in a row of adjusted double-digit sales growth to its new acquisition, its share price should continue to fetch the high P/E ratio it now sports.

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Fool contributor Brian Orelli, Ph.D., doesn't own shares of any company mentioned in this article. Pfizer is an Inside Value pick. The Fool has a disclosure policy.