Bust out your 2009 pharma-merger brackets Fools: We've got another winner headed to the final four. Merck (NYSE:MRK) announced today that it's purchasing Schering-Plough (NYSE:SGP) for $41.1 billion in a cash and stock deal.
Which pharmaceutical company is going to be the last one standing when all is said and done? Merck may be the underdog at roughly half the market cap, but I think the new Merck looks a lot better than a combined Pfizer (NYSE:PFE) plus Wyeth (NYSE:WYE).
Smarter financials
The Merck-Schering deal looks better partially because it's two-thirds the size of the Wyeth deal. As Pfizer has shown in the past, large companies are hard to integrate. There's bound to be slowdown in productivity as things get situated, so you might as well pay less for the pleasure.
The financials of the deal also look more appetizing. Merck is buying Schering-Plough for 15.7 times its 2008 free cash flow compared to Pfizer's $68 billion deal that works out to 17.6 times Wyeth's free cash flow from last year. Overpaying causes more cash to be eaten up to service the debt taken on to do the deal instead of being used to strengthen the company's pipeline through licensing deals and acquisitions, or returned to shareholders through dividends.
Speaking of dividends, Merck's keeping its dividend at the current level compared to Pfizer, which chopped its dividend in half. The dividend was one of the main reasons that I liked the pre-acquisition Pfizer; as long as the dividend looked fairly safe, there was a floor on the stock price, and investors got paid to wait for growth in the future. Merck has structured its deal so that it can continue to pay shareholders through the transition.
Both Merck's and Pfizer's shareholders are getting a smaller piece of a bigger pie since both acquisitions were paid for partially with shares, but Merck's shareholders aren't paying as much. Merck is using more valuable shares at just over nine times free cash flow to fund part of the purchase, compared to the seven times free cash flow that Pfizer was trading at before the deal was announced.
Touchy feely looks better too
The suits that negotiated the Merck-Schering deal probably based the acquisition mostly on how the numbers worked out, but shareholders should also use their gut to determine whether Merck's acquisition is a long-term winner.
First and foremost, the deal looks good because Merck is a partner with Schering on their cholesterol drugs, Vytorin and Zetia. There's bound to be some synergies involved in combining the joint venture into one company, but more importantly Merck knows exactly what it's getting. Sales of the drugs have been hurt by a report last year that Vytorin -- a combination of Zetia plus Zocor -- was unable to reduce plaque in a neck artery more than Zocor alone. That's caused doctors and their patients to favor statins like Pfizer's Lipitor, AstraZeneca's (NYSE:AZN) Crestor, or generic versions of Merck's Zocor. It's unlikely that any other company could know when the bleeding will stop or be able to figure out the true value Schering's half of the joint venture better than Merck.
Schering has a well stocked pipeline, and that's one of the main reasons that I liked Schering more than Merck -- and therefore why I can't think too little of Merck coveting it. With 13 drugs in phase 3 trials and another 16 in phase 2 (one being in two different trials), the acquisition should pay off for Merck down the line.
Better than nothing?
I can see how both Merck and Pfizer felt like they had to do something. Pfizer is facing a revenue cliff with Lipitor going off patent in a few years, and growth at Merck is looking rather lackluster for the next few years.
But there was an alternative; they could have taken a post-patent-cliff mulligan and restarted growth after the cliff as Bristol-Myers Squibb (NYSE:BMY) and Sanofi-Aventis (NYSE:SNY) both look like they're planning to do after Plavix, which they share, goes off patent.
Only time will tell, but I'm not convinced that bigger is necessarily better when it comes to Big Pharma. The opportunity to do a bunch of smaller deals might be a better choice for pharmaceutical companies, but, if acquisitions continue at this pace, investors may never get to find out.
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