Thursday, March 12, 2009

Marcial: Could J&J Make a Run at Schering-Plough?

Marcial: Could J&J Make a Run at Schering-Plough?

Wall Street is abuzz with speculation that Johnson & Johnson (JNJ) may try to muscle in on Merck's (MRK) $41 billion bid to buy Schering-Plough (SGP). So far, J&J is tight-lipped.

A potential J&J move on Schering may result in a bidding war, with J&J raising Merck's cash-and-stock offer of $23.61 a share and presumably pushing Merck into hiking its bid by about 10%, some analysts figure.

Analysts who follow the pharmaceutical industry aren't sure whether that scenario will indeed play out.

"A Good Fit"

"Could J&J come in and bid for Schering-Plough? The fit between the two companies is as good, if not better, than the fit between Schering and Merck," says Timothy Anderson, senior health-care analyst at investment bank Sanford C. Bernstein (Bernstein has done business with Schering and Merck.) He doesn't see many significant impediments to the deal but says "it is theoretically possible that J&J comes in and bids for [Schering] because the fit would be a good one."

Catherine Arnold, pharmaceutical analyst at UBS (UBS), says "a bid by J&J can't be ruled out" because of both strategic and financial reasons. That's partly because J&J and Schering co-market the anti-inflammatory drug Remicade; J&J distributes the drug in the U.S., while Schering controls the non-U.S. market. The joint venture also covers the anti-inflammatory drug golimumab, scheduled to be marketed later in 2009. Arnold believes J&J would surely seek to protect its rights to the anti-inflammatory drugs it is co-marketing, either by making a counterbid for all of Schering or by cutting some kind of deal with Merck. If it doesn’t, J&J could lose those rights should Merck/Schering decide that they want the drugs for themselves through some means.

Therein lies the problem: Part of the Schering-J&J agreement is that J&J gets full rights to Remicade and golimumab should Schering be acquired by another company. To get around this provision, Merck drew up a reverse merger deal in which Schering becomes the surviving company but retains the name of Merck—and will continue to be controlled by current Merck shareholders.

Bernstein's Anderson says it seems logical for J&J to challenge Merck on the deal and to at least try to extract something of value out of its venture with Schering on Remicade and golimumab. Merck has told analysts and the press that its interest in Schering goes beyond Remicade and golimumab. Nonetheless, Remicade is an essential part of the deal: It produced revenues of $2.1 billion last year for Schering, while J&J posted $3.7 billion in Remicade sales.

Bidding War Ahead?

UBS's Arnold says a J&J deal would almost surely require a 10% premium to Merck's bid, bringing a sweetened offer to around $25.98 a share. She says a move by J&J to outbid Merck would be out of character for the New Brunswick (N.J.) company, "but not impossible." J&J's largest-ever acquisition was its $16.6 billion purchase of Pfizer's (PFE) consumer health-care unit in June 2006. J&J hasn't entered into any bidding wars with its pharmaceutical or biotech peers, notes Arnold. However, the company faces numerous challenges such as stiffer competition in some of its diverse businesses, and particularly so in the pharmaceutical division where it could use more new drugs in development. So it may break from its traditional ways, argues the analyst, "in pursuing what we believe to be the most attractive target in the pharma space."

If that happens, the story won't end there. Merck certainly has the option of raising its bid above any potential offer from J&J, and still derive benefits from the higher-priced combination. Arnold figures Merck could go as high as $39 a share without damaging whatever benefits it will reap from the combination. However, J&J, she estimates, could go as high as $40.40 a share in its bid.

Shares of Schering have jumped since Mar. 6—the day before the Merck deal was announced —from 17 a share to 22.09 on Mar. 9, when the offer was disclosed. The stock hit a 52-week high of 22.32 on July 15, 2008. Merck is down to 22 from a 52-week high of 45.73 on Sept. 9, 2008, and J&J has slid to 47 from a 52-week high of 72.76 on Sept. 9, 2008.

What's Schering's big appeal? Arnold estimates it will have the largest potential earnings growth rate in the pharma group from 2009 to 2015 and will be consistently near the top of its peers during those years. That could be plenty of inducement for a competing bid.

J&J spokesman Jeffrey Leebaw declined to comment.

Stay tuned.

Unless otherwise noted, neither the sources cited in Gene Marcial's Stock Picks nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.

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