US Major Pharmaceuticals
ACQUISITION
Merck & Schering-Plough: Merck, Made More
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Deal makes strategic and financial sense, our view of Merck is more
positive. Merck’s stand-alone earnings outlook was -6% in the period 2009-
2013 and is 5% with SGP. Further upside to our view is possible as MRK’s
guidance is high-single digit in this period. Therapeutic areas are of great
complement and little conflict.
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Our only point of discontent is whether SGP could have attracted a
higher price and we wonder if MRK’s bid is ex-autoimmune value. SGP
premiums on EV/EBITDA and 3-month undisturbed price (Exhibit 6) are
higher than group, but intrinsic value on SOTP and DCF imply $24 and $26
respectively, with autoimmune but without synergies.
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MRK seems oversold, but a few matters deserving future diligence
keep us on the sidelines. (1) MRK’s avoidance of the autoimmune change
of control clause does not seem as certain as claimed; (2) the potential for a
JNJ bid may be low (20-25%), but is not impossible given strategic and
financial complement of JNJ (see below and Exhibit 15); (3) despite MRK’s
vast improvement with SGP versus standalone, our EPS growth is below
guidance and we would like to better understand the drivers of the difference.
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MRK accretion is noteworthy even without autoimmune. MRK’s bid as
proposed, including $3.5 Bn synergies, would offer 39% year 3 accretion if
the autoimmune franchise is included, 29% if not. To stress test the
financial flexibility for MRK, we evaluated the price at which deal break-even
would occur (without additional synergies) and this yielded a $39/share price.
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A JNJ bid can’t be ruled out given both strategic and financial merits.
A JNJ bid would almost certainly include an exchange of value by MRK for
the cholesterol business. A 10% premium to the MRK bid and the same
synergy targets implies 16% accretion in year 3. A stress test of JNJ’s
financial flexibility to bid on SGP suggests the price for deal break-even
(without additional synergies) is $40.
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MRK and SGP stand-alone EPS changes are described in more detail in
the note and follow 10-K adjustments. Our EPS changes for MRK are
from $3.18 to $3.19 in 2009 and from $3.21 to $3.19 in 2010; for SGP,
unchanged at $1.77 in 2009 and from $2.07 to $2.04 in 2010.
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MRK target price lowered to $24. MRK’s value as a Newco is $30
assuming the current proposal, no counterbid and retention of autoimmune.
Given near-term uncertainties (and absent further diligence) of autoimmune
and the possibility of a counterbid by JNJ, we are currently valuing MRK as a
standalone, for which our valuation is reduced from $30 to $24, primarily a
reflection of a lower S& P multiple and lower sector relative P/E multiple.

MRK Recognizes SGP’s Merits
As a stand-alone company, SGP has the least patent exposure and most attractive
earnings growth in the 2009-2015 period (over 10% CAGR). SGP also has multiple latestage
products to drive medium to long-term growth, of note TRA (blood thinner to prevent
acute cardiovascular events for those of risk), boceprevir (hepatitis c), Bridion (anesthesia)
and golimumab (arthritis with JNJ). SGP and MRK have complementary programs in
CNS, oncology, women’s health, cardiovascular. MRK’s modest presence in consumer
health and animal health can be augmented by SGP assets. This is described in more
meaningful detail later in this report.
MRK’s substantial accretion from a SGP deal is driven by their ability to take advantage of
SGP’s attractive growth profile, along with earnings synergies in a take-out scenario as
proposed on March 9th. The announced purchase price is $23.61 per SGP share,
comprised of $10.50 cash/share and approximately $13.11 MRK stock/share, based on a
0.5767 exchange ratio (Exhibit 1).

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