Analysis: Wisdom of Merck deal may hinge on Remicade ruling

NEW YORK Thu Feb 10, 2011 3:37pm EST

A view of the Merck & Co. campus in Linden, New Jersey March 9, 2009, after Merck & Co Inc said it would acquire Schering-Plough Corp in $41.1 billion deal, widening Merck's pipeline and diversifying its portfolio of medicines. REUTERS/Jeff Zelevansky

A view of the Merck & Co. campus in Linden, New Jersey March 9, 2009, after Merck & Co Inc said it would acquire Schering-Plough Corp in $41.1 billion deal, widening Merck's pipeline and diversifying its portfolio of medicines.

Credit: Reuters/Jeff Zelevansky

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NEW YORK (Reuters) - Merck & Co (MRK.N), which long warned that mega-mergers don't pay off, could see the rationale for its own $41 billion purchase of Schering-Plough unravel if it loses rights to arthritis drugs that underpinned the deal.

An arbitration panel is due to decide whether Merck should retain overseas sales rights to the blockbuster arthritis drug Remicade and potentially more lucrative follow-up medicine Simponi, or must cede them to Johnson & Johnson (JNJ.N) as a result of a change of control at Schering-Plough.

That ruling could come at any time, but analysts believe it will likely be in the current quarter, or soon after.

"We have Remicade as almost a $3 billion drug in 2011 ... so it obviously would be a huge blow to them if they lost that," said Jon LeCroy, an analyst with Hapoalim Securities.

Morningstar analyst Damien Conover said loss of Remicade and Simponi rights could spark a 5 to 6 percent sell-off in Merck shares. Moreover, analysts say it could erase 8 percent from Merck's expected 2012 profit.

"If they lose complete access to those drugs, you have to ask whether the Schering-Plough acquisition still holds up. A lot of the merger benefit would be destroyed," said Conover. A favorable decision would boost shares only modestly because most investors expect a Merck victory, he said.

Merck investors already sustained a double blow in recent weeks: A major clinical setback for its blood clot preventer vorapaxar, long seen as a crown jewel of the Schering-Plough pipeline, followed by the company's move to withdraw its long-term profit forecast.

New CEO Kenneth Frazier said Merck must preserve its research budget even if means diminished earnings goals. In contrast, Pfizer Inc's (PFE.N) new chief Ian Read said he would slash his R&D budget to meet profit targets.

Sanford Bernstein analyst Tim Anderson speculated that Merck yanked its profit forecast through 2013 because it miscalculated the cost of making the Schering deal pay off.

Investors are worried a loss in the arbitration could be the third, and most painful, shoe waiting to drop.

Merck had long eschewed large mergers, relying on its own laboratories for new products. But its resolve wavered as many of its most promising experimental drugs failed in clinical trials or were shot down by regulators.

A GOOD DEAL?

Analysts cheered the 2009 Schering deal because it gave Merck an envied lineup of drugs in late-stage development. It also gave Merck full control of blockbuster cholesterol fighter Vytorin and the immediate payoff of Remicade and Simponi overseas rights.

"If they lose badly the Remicade/Simponi arbitration, and we've already written off vorapaxar, then two of the value drivers from Schering have gone away and will make the deal look much more expensive," said Les Funtleyder, a portfolio manager for Miller Tabak & Co.

It had been considered fairly cheap by mega-merger standards, costing about 13 times Schering-Plough's earnings over the prior 12 months, compared with multiples of 27 to 56 times trailing earnings for other giant deals in the industry.

Pfizer engineered three huge mergers in a decade -- a $114 billion acquisition of Warner-Lambert in 2000, a $60 billion purchase of Pharmacia in 2003, and a $67 billion deal for Wyeth in 2009. Pfizer's shares and earnings have steadily declined over the period and the wisdom of the Wyeth deal, which was lauded by analysts, is still to be proven.

While cheap by Pfizer standards, the Merck-Schering deal is looking like less of a bargain all the time.

Vorapaxar was expected to generate peak annual sales of $5 billion or more, for prevention of heart attacks and strokes. Those forecasts evaporated last month after the drug was deemed unsuitable for stroke patients.

Sales forecasts have also waned for boceprevir, a hepatitis C treatment gained from Schering that appears to be less effective than a similar medicine developed by Vertex Pharmaceuticals Inc (VRTX.O). Both await FDA approvals.

These and other disappointments underscore the importance of the Remicade arbitration ruling.

Merck went to great lengths to structure the deal as a reverse merger under which smaller Schering-Plough technically acquired Merck -- a strategy that many legal experts and analysts expect to pass muster with an arbitration panel consisting of three former federal judges.

But the combined entity retained the Merck name and stock symbol and is run out of Merck's corporate headquarters by Merck executives. Therefore, a ruling based on the spirit rather than the letter of the law could go against Merck.

Regardless, there may be compelling reasons to stick with Merck. Share-price declines have made it one of the cheapest stocks among large drugmakers. It trades at only about 8.5 times the company's expected 2011 per-share earnings, versus an average multiple of 10 for its rivals.

Merck also has other promising experimental drugs and already marketed medicines with substantial room to grow.

While years away from reaching the market, anacetrapib recently wowed researchers by demonstrating an ability to dramatically boost "good" HDL cholesterol and potentially reduce the risk of heart attack and stroke.

Other potential big sellers include another HDL-boosting drug called Tredaptive, a drug to reverse effects of anesthesia called Bridion, and two recently launched medicines: Dulera for asthma and Saphris to treat schizophrenia.

"They will pull through because they're Merck," said Funtleyder, referring to its history of strong research. "And to the extent that things from Schering actually deliver, that's just an additional upside."

(Reporting by Ransdell Pierson and Bill Berkrot; Editing by Gary Hill)

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