"Et Tu, Brutus?" If PFE-WYE is a "Blunder", What is Sch-Merck?

Bart Boyer, of Parsec Capital is arguing, in The Wall Street Transcript this morning -- that Pfizer's acquisition of Wyeth makes no sense -- that Pfizer is paying 60 percent of its market cap, for a 20 percent increase in sales revenue. Fair enough (insofar as his analysis takes us -- though I might quibble slightly with his math -- let's just accept his figures). So -- what does this say about Merck's proposed bust-up of Schering-Plough? Let's take a look:

Merck's market cap, this morning, is about $65.4 billion. Merck is now set to pay about $45 billion (given the increases in price, of both companies' stocks, from March 9 2009, when the deal was "only" worth $41 billion), for Schering-Plough.

Okay, Merck is paying about 68 percent of its market cap to acquire Schering-Plough (45/65.4, equals about 68 percent). In turn, it will theoretically get a 50 percent increase in revenues.

But that is, in fact, only theoretically. Why?

Recall that the Sanofi-Aventis/Merial deal takes back at least $4 billion; and if the Intervet call option is exercised, one-half of perhaps $10 billion goes away. So, post close (and, after "folding-in" the Merck-Schering-Plough cholesterol joint venture, and any overlapping intercompany sales), we will need to strip out some $11 billion in sales, in the aggregate. By my calculations, then, only some 43 percent of Schering-Plough's current sales will be incremental to Merck's. Not too terrible. But sales revenue certainly doesn't tell the whole story.

Look at how little the proposed Merck bust-up of Schering-Plough adds to overall EBITDA: by paying 68 percent of its market cap, New Merck achieves only a 34 percent increase in EBITDA [$3.89 billion EBITDA (Old Schering), divided by the combined $11.47 billion of EBITDA -- or $7.58 billion (Old Merck) plus $3.89 billion (Old Schering)]. Ouch.

Similarly, it only adds about 30 percent to Net Income Available to Common Shareholders [$2.45 billion of Net Available to Common (Old Schering), divided by the combined $8.17 billion of COMBINED Net Available to Common -- or $5.72 billion (Old Merck) plus $2.45 billion (Old Schering)]. But it "costs" 68 percent of Market Cap, to get 30 percent more net income for the common shareholders. Again, Ouch. Moreover, each of these is BEFORE we strip out EBITDA and Net Available to Common generated solely by the to-be-divested businesses.

So, if we are to accept Boyer's logic, it would be cheaper (from a capital planning perspective) to simply retire a whole mess of "Old Merck" common shares, with all the money Merck just raised, in the debt markets, to fund the would-be Schering-Plough bust-up.

Here is the Boyer quote (on Pfizer/Wyeth):

. . . .Take an example like Pfizer that it is getting ready to buy Wyeth. They are spending about two-thirds of their market capitalization for a company that will increase revenues by 20%. That makes no sense, that's a corporate blunder in our opinion. If you have that much money, simply shrink capitalization to offset the 20% revenue decrease. . . .

Now, what is the take-away?

It is that Mr. Boyer is overstating his case. He factors nothing in for cost savings, from removing duplicated infrastructure, and severing perhaps tens of thousands of workers. That is the single most important variable in all mega-mergers: how much additional "synergy value" may be driven out of the cost structure of the combined companies? It is, at present, completely unknown -- in the case of both of these mega-pharma deals.

Still, we ought to seriously consider the fact that Merck will effectively "shrink" the combined company, just to get the deal done -- selling off at least half -- maybe more -- of Animal Health, perhaps partnering off a chunk of Consumer Health, and almost certainly, surrendering a chunk of the Remicade/Simponi franchise revenue -- to Johnson & Johnson. And finally, remember -- there will be unicorns, lurking everywhere, in these woods. . . .

Yet, and still, Mr. Boyer -- if it's good for the goose. . . it's probably good for the gander, too.