What Credit Suisse -- and Others -- Are Missing About Schering. . . .

First, read Credit Suisse's money paragraphs, from today's research note:

. . . .There is much controversy over “the bottom for Vytorin”. Of course prescription volume for this franchise will be driven by prescription category growth and market share. The recent JUPITER study presented at the recent meeting of the American Heart Association should serve as an inflection point for statin prescribing, with AstraZeneca’s Crestor as the greatest beneficiary. That said our US forecast volume growth of 3.5% in 2009 may prove conservative. As to market share we assume Vytorin loses share through 2009, but does gain modest share in 2010. Our thinking is that patients [switched from Vytorin] from the ENHANCE and SEAS fall-out have largely been placed on generic simvastatin at low doses.

Accordingly, many patients are not achieving LDL-C targets and will need a more potent option. The competitive advantage of Zetia (and Vytorin) is to provide high potency (LDL-C reduction of 40% or more) with a better safety profile in regards to myopathies than many other drugs in the market. This will mean that share gains in the future are possible, a counter consensus view.. . .

I am sure these Credit Suisse folks are very bright -- I just think they have overlooked a few rather-important things:

(1) First, and most fundamentally -- to conflate simply lowering LDL-C levels -- with actual outcomes-efficacy, is a glaring scientific flaw in the above analysis. That science -- the actual statin-science -- will drive EPS growth at AstraZeneca (Crestor), but not at Schering-Plough. There is simply no science to suggest that the gut mechanism-of-action of Vytorin and Zetia is effective at reducing cardiovascular risks. Contrast this with the statin data -- it establishes that the liver mechanism-of-action does, in fact, improve outcomes. Most doctors writing scrips now understand these facts -- it seems some stock analysts. . . . don't.

(2) Even if we overlook (1), Vytorin and Zetia will never again command a three- to four-times price premium over branded statins, and they will never command a ten times premium over generics. They simply aren't ten times better.

(3) Forgetting (1) and (2) -- from 2009-2012, almost all third-party payers will be racheting back on drug costs -- agreeing only to lower average selling prices -- and opening lucrative new market-niches only for drugs with proven efficacy, in these deficit-laden times. There is simply no reasonable scenario where Vytorin returns to even 5% or 6% growth in 2010 and beyond (As the rather goofy-Credit Suisse models would suggest). It is simply a pipe-dream of one Fred Hassan.

(4) Concretely, and toward that pinched-budgetary end [in (3)] -- the state formularies (in New York, Illinois and California) are already shifting away from Vytorin. The replacement drug of choice? Any generic statin. Now, how long until the federal programs make the same shift? If (and when) so -- um, game over.

(5) Schering was -- back in the halcyon days of mid-2007 -- counting on huge Vytorin cash-flows and earnings to bank-roll all that extremely expensive ramp-up -- from pipeline, to FDA-filings, to market -- on five major drugs -- all at once. That is no longer possible -- at best, Vytorin will be hobbled by price concessions, shrinking share and (perhaps worst of all) the possibility that IMPROVE-IT will turn out to be a bust, from a scientific-point-of-view.

(6) Schering simply overpaid for Organon. And while those businesses generate pretty solid cash-flow-levels, they are not nearly the profitability engine Vytorin once was. Launching five major projects through FDA concurrently is a very expensive approach to long-term stability. I don't believe Schering can manage all of that, as the swoon in Vytorin/Zetia accelerates in 2009. Remember here that Schering has some very high-coupon debt and preferred to service, as a result of spending almost $15 billion on Organon.

(7) In August of 2010, and as a bullet-corallary to (6) above, Schering must convert all of its Series B Preferred (some $2.5 billion worth) into common stock -- it must issue new common. All of that common must be covered by new incremental earnings, just to hold steady -- on the EPS line. Even if Vytorin unit-sales grow 6 percent -- actual reported revenue never will grow that much -- Schering will have to engage in drastic price cutting to gain share. And, by the way -- doctors generally don't return to writing scrips on drugs they've found better alternatives for. So, net, net: no way -- and, no how.

Okay, that is the negative -- what is Credit Suisse "right" about? -- Well, currency fluctuations -- and the deleterious impact of the same -- on Schering, going into 2009 (and perhaps beyond):

". . . .Schering-Plough is the most exposed to this currency risk of any company in the US pharma group. . . . a particularly high concentration of European revenues (approximately 42% per our estimate), and some dollar-based manufacturing costs for Schering that do not provide an operational hedge to the weakness associated with European revenues, translated into the consolidated P&L. These improve the European based cash flow, but hurt the translational earnings for the Company.

We agree that currency is a material negative. . . ."

I simply think Credit Suisse's role in the Summer 2007 Schering offerings has colored its analysis here, and significantly -- to (an albeit pale) rosy shade. . . . Click the last two links, to read why I think so.