Investor's Business Daily, March 16th, 2007
Among major U.S. drug stocks, Schering-Plough tends to fly under the radar of better-known peers such as Pfizer and Merck.
That changed last week when Schering SGP said it would pay about $14.4 billion for Organon BioSciences, a unit of Dutch chemical and drug conglomerate Akzo NobelAKZOY.
It was the latest in a series of deals designed to bolster the pipelines of brand-name drug makers as they wrestle with generic competition, the loss of key patents and a dearth of new products.
Analysts say the driving factor behind the Organon deal is that it reduces Schering's reliance on its cholesterol drug franchise, which includes Vytorin and Zetia. About 60% to 70% of Schering's earnings come from its cholesterol drugs.
"Schering is really dependent on cholesterol drugs, so they needed some product diversity," said Jon LeCroy, analyst at Natexis Bleichroeder. "This deal allows diversity into women's health and animal health."
During a conference call with analysts, Schering-Plough Chief Executive Fred Hassan said Organon has five products in late-stage clinical testing and "a number of promising projects" in midstage clinical trials. Late-stage clinical trials include treatments for schizophrenia, infertility and insomnia.
"Organon will be an excellent fit with Schering-Plough -- strategically, scientifically and financially," Hassan said. "It builds on our growing strength in primary care, giving us immediate access to central nervous system and women's health care products."
Organon had around $5 billion in sales last year. The firm could add 10 cents a share to Schering-Plough's earnings one year after the deal closes, excluding costs related to the purchase. The acquisition should be completed by the end of the year.
Wall Street's reaction was minimal, with Schering's stock rising slightly on the day of the announcement, March 12. Shares fell back later in the week amid a larger market sell-off.
Eye On Efficiency
The addition of Organon comes at a time of financial strength for Schering. Unlike many of its rivals in the pharmaceutical sector, Schering has managed to produce steady growth the past couple of years.
The Kenilworth, N.J.-based company has grown sales nine quarters in a row, with seven of those gains in double digits. Earnings have increased at least 92% the past eight quarters.
Last year Schering logged $10.6 billion in revenue, up 11% from 2005. Profit more than doubled to 85 cents a share.
The Organon deal should contribute $500 million in annual cost synergies after three years, estimates analyst Chris Schott of with Banc of America Securities.
One key is how well Schering can improve Organon's operation, especially from an efficiency standpoint. In a recent report, Schott noted that Organon's pharma division had a 14% operating margin last year -- well below the pharmaceutical group average of around 27%.
"We believe the combined entity will have the opportunity to improve Organon's below-average operating margins," Schott wrote.
He does have concerns about one of Organon's drugs: asenapine for schizophrenia, which is in phase three trials.
"Pfizer PFE recently returned asenapine (after) mixed phase three results," Schott wrote."While still likely approvable, we would question the long-term sales opportunity for this product."
International Focus
Organon's lineup of animal health products might provide the biggest lift to Schering, LeCroy says.
Products in Organon's Intervet unit include Nobivac canine vaccines, the Bovilis biological for bovine disease control and eradication, and the Nobilis poultry vaccine.
Schering's line of animal health products includes Nuflor, an antibiotic for cattle, swine and fish; and Banamine, an anti-inflammatory for cattle, horses and swine.
Intervet will continue to operate out of its headquarters in the Netherlands. The unit's international presence is a plus, LeCroy says.
"Some companies can do better internationally in animal health than they can in the U.S.," he said. "That's especially the case in third-world countries, where the animal farming business tends to be good."
The fact that Schering made such a huge acquisition in the first place speaks to its inability to take other routes to growth -- including partnering up with smaller biotechs, an increasingly popular move among other big drug firms.
"Schering is not the partner of choice for a lot of products," LeCroy said. "It's tough to beat out Merck MRK and Pfizer, so Schering is stuck really scavenging right now."
He expects future deals to be much smaller in scale, at least in the near term.
Copyright 2007 Investor's Business Daily, Inc.
