I've been hearing a positive buzz about Schering-Plough (NYSE:SGP), a company that may be ripe for a turnaround now that it's being led by a new CEO.
It wasn't that long ago that Schering-Plough was considered a top-notch pharmaceutical powerhouse. Longtime readers may even remember that the stock was once a holding in our real-time, real-money Rule Maker Portfolio. The portfolio added Schering-Plough way back in August 1998 at $48.50 per share. Believe it or not, that trade looked like sheer genius for a while. The stock hit an all-time high of just about $60 around Christmas 2000. Today, more than five years later, the stock sits at around $16, down 73% from its highs.
It took a combination of events to unravel this once-proud company, most notably the complete decimation of the Claritin allergy franchise since the drug lost its patent protection last December. Two years ago, Claritin delivered $3.15 billion in highly profitable sales. Through the first half of this year, total prescription revenues worldwide for Claritin have dropped 85% to $221 million, of which less than $30 million were in the U.S., where the drug now sells over-the-counter.
This revenue shortfall caused Schering's first half earnings to come in at $355 million, a decline of 71% from last year's first half. Even worse, cash flow in the second quarter was so paltry that the company had to borrow to make its dividend payment.
But things had been going badly at Schering-Plough well before this year. The company has faced mounting regulatory and legal issues, one of which resulted in a record $500 million fine as part of a consent agreement reached with the FDA in May of last year in response to alleged unsafe manufacturing practices. It has also disclosed that it is the target of a federal grand jury investigation by the U.S. Attorney's Office in Massachusetts, among other problems.
In fact, the most recent 10-Q devotes as much space to assorted legal and regulatory woes as it does to the business of selling health-care products. Just this week, Schering paid $1 million to settle SEC charges that former CEO Richard Kogan violated Regulation FD last year by allegedly disclosing materially negative information about the business prospects to a roomful of analysts before releasing it to the public. This last likely prompted Kogan's resignation last November, after which the board commenced a search for a new CEO to lead the company forward.
The turnaround artist
In April, Schering-Plough appointed as its new CEO former Pharmacia chief Fred Hassan, who led that company's turnaround from 1997 before orchestrating its sale to Pfizer (NYSE:PFE) in a $60 billion deal in 2002. At the April 23 annual meeting, Hassan acknowledged that there would be no "quick fix" but outlined a five-phase process to rebuild the business. The first phase is to "stabilize" the company by getting on top of the regulatory and legal issues and stem further erosion, and the second phase will be to "repair" the culture to "embed a behavior of business integrity and compliance."
It didn't take long for Hassan to make an impact. After undertaking a 100-day, "360 degree" review of the company, Hassan announced drastic action in August, including a cut in the annual dividend from $0.68 to $0.22, officially ending a string of 19 consecutive years of increased dividends. Other stringent cost-cutting measures were taken, including the elimination of executive bonuses for 2003, a zero payout under the company's incentive plans, no merit increases through 2004, and a reduction in force through a voluntary early-retirement program. The company will save about $675 million annually in dividends and hopes to exceed $200 million from its austerity initiatives.
While the stock sold off on the news initially, in my opinion Hassan had no choice. And I'm impressed by his courage in taking the very tough but necessary steps to get Schering-Plough back on sound financial footing. This isn't a case where the management is asking employees to tighten their belts while executives go on living the good life, either. As part of the cost cutting, the company will sell its corporate jet and will eliminate executive dining rooms and travel. Hassan also waived his own incentive bonus that could have paid him as much as $2 million.
Too soon to tell
Despite my view that Hassan is exactly the man for the job, I don't believe investors should rush headlong into buying the Schering-Plough turnaround story just yet. After listening to a recent investor presentation by Hassan at the Bear Stearns Healthcare conference earlier this week (a replay is available on the company website), I just think way too many negative factors preclude a rapid turnaround. Hassan himself called this "much tougher" than what he faced at Pharmacia and has said that just the first two phases of stabilization and repair would take a minimum 18-24 months.
Turning around a drug maker isn't like turning around a great but tired franchise like McDonald's (NYSE:MCD). Getting a drug to market takes many years and many hundreds of millions of dollars, and blockbusters are rare. And the Claritin problems aren't over, even after losing some 97% of U.S. prescription sales. Next-generation Clarinex, which accounted for $600 million in sales in 2002, is due to lose marketing exclusivity in October 2004. Claritin's over-the-counter exclusivity will expire during the third quarter of 2003, which will cut into profits even further.
Schering will also be hurt by generic competition for $860 million drug Rebetrol sometime in the near future. Arguably, the only bright spot just now is Zetia, a new cholesterol drug marketed through a joint venture with Merck (NYSE:MRK). More than that will be needed to stem Schering-Plough's decline and resume its growth.
Turning Schering-Plough around will be a tough job, and it won't happen quickly. As much as I'd like to jump on the bandwagon, I think it will get worse before it finally gets better, making it a little too premature to buy the stock.
Zeke Ashton has been a longtime contributor to The Motley Fool, and is the managing partner of Centaur Capital Partners, LP, a money management firm in Dallas, Texas. Please send your feedback to [email protected]. At time of publication, Zeke owned shares of Merck in some managed accounts. The Motley Fool is investors writing for investors.
