Merck faces difficulties in bid to woo Schering

The announcement that German drug and chemicals maker Merck is prepared to pay $17 billion (€14.1 billion) for its compatriot Schering could be just the start of a complex bidding battle.

When Merck publicly confirmed on March 13 rumors of a pending unsolicited bid for Schering, the German pharma company, well known for x-ray, ultrasound, and MR contrast agents, lost no time decrying the offer as too low. Although the deal may still go forward, subject to shareholders' approval, negotiations could be complicated if competitors wade in, or if Schering opts to protect itself through a separate acquisition.

Merck formally advised Schering executives of its intended €77 (approximately $100) per share cash offer on March 10. The Darmstadt-based firm made its plans public the following Monday morning. Shareholders must now wait until early April for final offer details to be published, giving the companies time for negotiations. The door also remains open for a third party to raise the bidding stakes.

A union between Merck and Schering would create a kind of übercompany heavily oriented toward pharmaceuticals. Merck also has a substantial investment outside of pharma, specifically involving consumer chemicals, where it enjoys a global market leadership position in the liquid crystals used to make television screens.

Last year, sales of x-ray and MR contrast media, along with radiopharmaceuticals, accounted for 26% of Schering sales. Net sales of Schering's Magnevist, Ultravist, and Iopamiron agents increased 8%, 5%, and 1%, respectively, over 2004's figures. The company also received in October approval to market its novel blood pool agent Vasovist for MR angiography throughout the European Union. Schering is divesting its radiopharmaceuticals business, which last year had sales of close to $150 million (€125 million).

Schering and Merck are about the same size, as Merck tallied sales in fiscal 2005 of about $7 billion (€5.9 billion), compared with $6.4 billion (€5.3 billion) for Schering. Merck has around 29,000 employees worldwide. Schering has around 25,000.

Schering could serve as a springboard into markets that have largely eluded Merck. Although both have a large direct sales presence in Europe, Latin America, and Asia Pacific, Merck has only a token presence in Japan, with nine sales people compared with Schering's more than 700. Schering has more than 1200 sales personnel in the U.S.; Merck has none.

To gain control of Schering, Merck needs to amass at least 51% of the Berlin-based company's shares. It currently holds just under 5%, shares it bought up on the open market.

The success of any takeover hinges on individual shareholders relinquishing their stakes. Unlike Merck, which is controlled by family members, Schering lacks a strong family of stockholders to protect it against powerful outside interests.

Merck is clearly braced for a battle. It is not known whether the company will make a personal approach to German insurer Allianz, which currently holds an 11.8% stake in Schering. Allianz is keeping its views on the prospective deal to itself for now.

But Merck has already taken out space in Berlin newspapers in an attempt to convince Schering employees of the wisdom of selling up. The open letter, published March 14, advises workers that they should recognize the "once in a lifetime opportunity" to be gained from facilitating the merger.

"We certainly hope that they will look at the offer favorably, though of course we will have to wait and see," said Phyllis Carter, media spokesperson for Merck.

The intended offer price represents a 35% premium over Schering's average share price for the past three months, and 24% over the "unaffected share price." The Merck family has pledged to make a €1 billion ($1.3 billion) equity contribution to help finance the deal.

"We strongly support this transaction," said Jon Baumhauer, chairman of the Merck family council. "It is the right transaction at the right time, as it builds on achievements to date and improves the growth prospects of both companies."

Schering's executives have been less impressed with the figures. The buyout price was just 15% above the closing share price in Frankfurt on March 10. This, noted an official statement from the company's board, "significantly undervalues Schering and its prospects as an independent specialized pharmaceutical company."

Subsequent reports have suggested that Schering will advise its shareholders to reject anything less than a 30% to 35% premium over the March 10 price. Whether shareholders heed such advice remains to be seen. Schering is also reportedly considering a takeover of its own, if a suitable target can be found in time. Merck would then be faced with a more expensive and complicated deal.

Merck's willingness to up its buyout price - either now or in the future - is open to question. Although the company has not ruled out raising its bid further, it has publicly stated that financing arrangements should not force its intended acquisition to be split up.

"Our intention is to make a bigger, stronger company, not to go in wholesale and clean it out," Carter said. "We don't plan any major layoffs. We want to make a world-class global pharmaceutical company."

A merger between Schering and Merck could create a pharmaceutical giant. The two companies logged pharmaceutical sales of $7.2 billion (€5.6 billion) in 2005. Their joint R&D budget comes to $1.7 billion (€1.3 billion). Together, they would create Germany's second-largest drug manufacturer behind Bayer.

Schering has recently focused its activities on four areas with substantial growth opportunities: gynecology and andrology, oncology, specialized therapeutics, and diagnostic imaging. This streamlining has resulted in the divestment of its radiopharmaceutical business CIS bio international to a Belgian consortium. The deal could close in the first half of 2006.

Merck has synergies with several of Schering's core pharma businesses, but executives expect the complementary nature of the companies' therapeutic products to drive growth. The complementarity is not so great, however, that it would arouse the suspicions of antitrust officials.