Two years on from Merck & Co’s (MRK) $41bn acquisition of Schering-Plough, a major threat to the value of a couple of its key assets has been removed (J&J the elephant in SchMerck's room, November 4, 2009).
News that Merck and Johnson & Johnson (JNJ) have resolved their arbitration dispute over the commercial rights to arthritis antibodies Remicade and Simponi was greeted with tangible relief by Merck shareholders. Share gains of 3% to $34.95 in early trade reflect that the settlement removes the risk that Merck could have lost all rights to both products. Meanwhile J&J’s stock rose 1% to $60.62, the resolution earning the healthcare giant better deal terms which should add over $6bn to the company’s revenues in the next six years alone (see table below).
Compromise
Merck’s purchase of Schering-Plough was actually structured as a reverse merger, designed specifically to avoid triggering a change of control clause in Schering-Plough’s licensing agreement with J&J over rights outside the US to both Remicade and Simponi.
J&J appeared to have the stronger logical argument that a change of control had taken place, while Merck was placing its faith in winning the dispute on technical and accountancy grounds (Event - Merck continues to play down J&J arbitration but risk remains, August 3, 2010).
The ruling Friday, which arrives 12 months later than originally anticipated when the Merck-Schering-Plough deal closed, sees Merck relinquish its rights to both products in a number of global markets, including: Canada, Central and South America, the Middle East, Africa and Asia Pacific.
As of July 1, Merck will only sell Remicade and Simponi in Europe, Russia and Turkey, which the company estimates accounted for 70% of its revenues last year from both products.
With Merck giving up 30% of its revenues from both products, the table below estimates the extra sales that J&J should gain from the revised deal, roughly $1bn per year based on current estimates from EvaluatePharma.
The table also includes the $500m one-off payment from Merck to J&J and a calculation for the slight gain from improved profit share terms which sees J&J receive an extra 8% of the profits until 2014 – this is estimated at $282m over the next two and a half years.
| Annual Sales/Profits ($m) | |||||||||
| Company | Product | Commercial rights (pre-arbitration ruling) | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 |
| Merck & Co | Remicade | WW ex USA, Japan, China, Taiwan & Indonesia | 2,714 | 2,919 | 3,006 | 2,984 | 2,845 | 2,601 | 2,311 |
| Simponi | WW ex USA, Japan, China, Taiwan & Indonesia | 96 | 252 | 414 | 598 | 756 | 904 | 1,055 | |
| Total Merck franchise sales | 2,810 | 3,171 | 3,420 | 3,582 | 3,601 | 3,504 | 3,366 | ||
| 30% sales | 843 | 951 | 1,026 | 1,075 | 1,080 | 1,051 | 1,010 | ||
| One-off payment | 500 | ||||||||
| Additional J&J revenue (less 50% sales in 2011) | 976 | 1,026 | 1,075 | 1,080 | 1,051 | 1,010 | |||
| Current Remicade Profit (11-13) | 772 | 807 | 789 | ||||||
| Current Simponi Profit (11-13) | (66) | 0 | 92 | ||||||
| Total Merck profit at 58% | 706 | 807 | 881 | ||||||
| 8% profit swing to J&J (less 50% in 2011) | 49 | 112 | 122 | ||||||
J&J says the new deal will not significantly impact its earnings this year and will update the market on what it might mean for future years when it reports first quarter results next week.
UBS analysts estimate around a 1% gain to earnings-per-share (EPS) this year and a 2% improvement to EPS for 2012 and beyond. They also point out that J&J is gaining access to some of the higher growth markets, highlighting greater potential beyond what might currently be forecast.
Similarly, Merck is sticking to its previous guidance for earnings this year, although official estimates for what the impact might be in future years are unlikely to emerge – the company recently withdrew its longer term guidance, which did not go down well with investors.
UBS estimates a 1-2% reduction in Merck’s EPS from 2012 onwards and suggests that any loss from this deal will be offset by additional cost-cutting.
Yet the real impact for Merck is the removal of a major issue hanging over the company, hence the share price relief Friday. Although the company is giving up around 30% of its rights to these important products, it could have been much worse and prompted some serious questions about the strategic rationale and valuation of its acquisition of Schering-Plough.
Throughout the arbitration process, J&J had nothing to lose and potentially a lot to gain. Merck had much to lose and little to gain. Given the high stakes involved, a compromise of the kind announced Friday was likely but still comes as a relief to Merck.
