Saturday, August 14, 2010

Pfizer Vs. Merck: Working Capital, And Intangible Assets: Post Merger Write-Off Comparisons!

Forgive me -- I've held this for a Saturday (and a rainy one, at that!), as this will be a rather longish (and weedy) financial analysis. The top line here is that the world's No. 1 drug maker (by revenue), Pfizer -- is quickly pulling away from its nearest competitor -- New Merck (the No. 2 drug maker by revenue) -- as each finishes swallowing their respective mega-transactions from late 2009 (on fundamental financial metrics, if not yet share price).

I should also note that Pfizer's disclosures -- by dint of its election to combine all existing restructring programs into a single, rolled-up discussion of how those charges are affecting continuing operations -- make for much clearer understanding of the "puts and takes" in Pfizer's Wyeth integration efforts.

By way of contrast, Merck clings to the largely outmoded, and (either intentionally, or perhaps not so) obscuring method of reporting each restructruing reserve, going back to 2008, at each company -- Old Merck, and Legacy Schering-Plough, individually -- as a set of at least five separate, but interrelated canopic jars. This makes for difficult "apples to apples" comparison of the Merck v. Pfizer SEC-required presentations. Note to Peter Kellog: When one crosses the fourth" active restructuring reserve" barrier, it would be advisable to have your reporting staff make the effort to roll all of these up, into one -- and report them in the aggregate, for easier investor understanding. [Of course, that would eliminate any possibility of shifting, or "double counting" -- of benefits opportunities, as well.]

So, do take this as a working model only; I have not tried to "go behind" Merck's disaggregated charges and combine them -- nor have I tried to disaggregate Pfizer's and rebucket them, individually. Instead, I have chosen to compare the way each of these hevyweights recites their respective adjustments to reconcile non-GAAP reported results to GAAP (SEC required) results. On to it, then:

In the first six months of 2010, Merck recorded (at page 49) $4.03 billion of purchase accounting adjustments (on a $41 billion transaction -- the bust-up of Schering-Plough). Meanwhile, Pfizer recorded purchase accounting adjustments during the same six months of about $3.69 billion (at page 47 of its Form 10-Q, filed Thursday) -- on its $68 billion acquisition of Wyeth.

During the first six months of 2010, Merck's cash provided by operating activities (page 53) was $4.7 billion -- on worldwide sales of $22.8 billion, or an about 21 percent sales to cash-flow turnover. Respectible, indeed. In the same period, Pfizer reported it had spent more cash than it took in (at page 50), resulting in negative cash flow from operating activities of $1.5 billion. At first glance that's not great -- however, when we lift the hood, we see that Pfizer paid taxes -- in cash -- of $11.3 billion, related to decisions made in the Wyeth integration. [Merck actually reduced its reserves for taxes by 3 percentage points in the period; setting up the possibility that it may have a future charge of size, should the IRS disagree with its accounting for the Schering-Plough transaction.]

So, if one sets aside this Pfizer tax payment, Pfizer actually generated or "threw off" cash of $9.8 billion. All of this on $34 billion in worldwide sales -- a nearly 29 percent sales to cash-flow turnover. And significantly, Pfizer is sitting pretty, should the IRS come calling -- that is, it has made a large "down payment" on any future taxing inquiries, on its accounting for the Wyeth purchase.

Next, Pfizer's working capital increased from $24.4 billion to $26.4 billion in the 2009 to 2010 six-month period (page 49). As a percentage of total period sales, that would be 77.6 percent -- on total asset base, it would be 13.8 percent. By contrast, New Merck's same period working capital fell from $12.7 billion in 2009, to $10.8 billion in 2010 (page 53). As a percentage of total period sales, that would be only 47.4 percent (or nearly 50 percent lower than Pfizer's comparable ratio), and on total assets, it would be 9.43 percent -- so No. 1 Pfizer is generating, about 32.6 percent more working capital, for each dollar of assets it carries on the balance sheet -- when stacked up against No. 2, Merck.

Merck's SEC Form 10-Q [at page 46]:

. . . .Additionally, in the second quarter and first six months of 2010, these costs include $1.1 billion and $2.3 billion, respectively, of expense for the amortization of intangible assets and $560.7 million and $1.8 billion, respectively, of amortization of purchase accounting adjustments to Schering-Plough’s inventories recognized as a result of the Merger. . . .

The amortization of intangible assets and purchase accounting adjustments to inventories recorded in 2010 as a result of the Merger and the restructuring charges reflected in both periods as noted above had an unfavorable effect on gross margin of 16.6 and 0.8 percentage points, respectively. Gross margin was 57.1% in the first six months of 2010 compared with 76.2% in the same period of 2009, which reflect 18.9 and 0.6 unfavorable effects, respectively, relating to the amortization recognized in 2010 and restructuring charges. . . .

Pfizer's SEC Form 10-Q [at page 42]:
. . . .purchase accounting charges of approximately $727 million in the second quarter of 2010 and $2.1 billion in the first six months of 2010, primarily reflecting the fair value adjustments to inventory acquired from Wyeth in 2009 that was sold in 2010. . . .

Of particular concern here (above) is the idea that Merck has taken (on a proportionate basis) much bigger writeoffs, on intangibles -- (i.e., one time cash flow enhancing items) -- in connection with busting up Schering Plough (a $41 billion transaction), than Pfizer has taken, with regard to Wyeth (at $68 billion).

Specifically, $2.3/$41 equals a 5.6 percent writeoff ratio, on the legacy Schering-Plough assets, as opposed to a mere $2.1/$68 or 3.1 percent writeoff ratio at Pfizer, on Wyeth.

Actually, there is much more to say, here -- but I am out of time at the moment. I'll come back to finish these thoughts, likely on Sunday afternoon.

1 comment:

Anonymous said...

Interesting stuff!

Ties in nicely with the other signs that seem to indicate that Merck is strapped for cash....
Do analysts/investors ever go back to compare statements on the products in development? (as it appears Merckc has written off many, did they pay way too much?)

Or is the EPS the only short term vision and point of focus for both the company and Wall street?