Sunday, May 19, 2013

2013 Thesis: Merck's Stock Is Almost Certain To Rise -- Through At Least The End Of Year

There will be dips, and there is always the remote possibility of some vast disaster hitting Merck's sales line in 2013. That much must be said at the outset. But it would have to be a more than 10 per cent real decline, to matter this year1. Why? Well, because Merck is pulling some non-operating financial levers, and very adroitly so, at the moment.

In sum, I'll conservatively predict an overall three to six per cent Merck NYSE stock price increase, net of everything else, by year end 2013. This will be true, I predict, even if not all its expected 2013 "in the pipeline" FDA approvals materialize.

With all the financial engineering now being laid into Merck's second half of 2013, it is hard to see how the stock won't -- in general -- rise more often (and in greater amplitudes) than it sinks. It is likely that some $10 billion worth of Merck's common stock will go back into its treasury account during 2013, decreasing outstandings. It is also highly likely that Merck will bring home a like amount of cash, from overseas, at near-nil tax rates, and thus pay off most of the debt it issued last week. [Of course, not one for one (many of the trauches are multi-year) -- but the cash returned is fungible, and will decrease interest expense -- and soon.] Thus, every penny it doesn't spend on taxes (for repatriating dividends) will fall right to the EPS line, and be levered with a debt reduction effect.

And that EPS line will garner the benefit of a smaller denominator -- over 12 per cent fewer outstanding shares over the life of the buyback, which will concentrate Merck's reported earnings over a smaller base of shares. This EPS levering will begin slowly, as the share equivalents are counted on 360 days outstanding as a linear average, in a year -- but the share count will drop significantly in the back half of 2013, if Merck gets started repurchasing shortly. [And remember, Merck's dividend is nearly a riskless almost four per cent cash return, every year, on each share.]

Now, on top of all of that (the factors within Merck's control), we will see an "out of Merck's control" knock-on effect. That knock on effect will appear, as many of the investment banking houses (through their buy side analysts) shortly start increasing their 12 month targets, for Merck's NYSE stock price, even if sales of Januvia® remain fairly underwhelming through all of 2013. They will do so, because they know that the above financial structuring steps will net, net actually increase Merck's unrestricted cash flows, by year end (and very tax efficiently so), and in perpetuity. UPDATED: Here is a list of bankers, from which I'd expect we will see increased 12 month NYSE price targets -- as each of them were underwriters of Merck's debt last week, and each of them undoubtedly have clients holding Merck stock, even if the smallest among them don't hold Merck stock directly as a firm. The names cover all of Wall and Broad: BNP PARIBAS, Deutsche Bank Securities, J.P. Morgan, Morgan Stanley, BofA, Merrill Lynch, Citigroup, Credit Suisse, Goldman, Sachs & Co., HSBC, RBS, UBS Investment Bank, Drexel Hamilton, Santander, SOCIETE GENERALE, Standard Chartered Bank, SMBC Nikko, US Bancorp, Wells Fargo Securities and The Williams Capital Group, L.P. [End, updated portion.]

Afterall, even if Merck pays somewhat higher prices, on the NYSE, for these repurchased shares (due in part to the conflicted interests the investment bankers now have -- to get their Merck shares, and those of their clients, repurchased at marginally higher prices) -- Merck's tax benefit will very likely still outstrip the increase in Merck's NYSE quoted price per share. That is, I don't expect that Merck's NYSE price will increase by more than the tax rates -- on a percentage basis -- had Merck repatriated the same amount of offshore cash, using a strategy that required Merck to pay "full-freight" federal income taxes.

In short, the (would-be) Masters of the Universe on Wall Street are lining up, all with powerful incentives to drive Merck's stock price north -- almost without regard to how Merck's operating business fundamentals pan out in the back half of 2013. So, even a slightly better than expected performance from any of the operating businesses, in 2013, will magnify the effect of all the above financial manuevering.

My advice? Do not go short on Merck in the rest of 2013 -- or buy puts -- unless you plan to buy and hold a multi-year position.

The scenarios for sustained NYSE price declines, at Merck -- are all but evaporating, even if currencies take another 7 or 8 per cent from the global sales line -- by year end. You've been warned. Know that Merck's stock is over 75 per cent held by large institutional investors, and they've figured all of this out, as well. They will sell a little, as the stock rises, and buy a little more, if the stock dips. This is essentially a downside protection structure for Merck's common stock.

1. I expect the same effects will appear at Apple in 2013 through 2014 -- only in even larger proportions -- as its benefits from the same strategies will be proportionately-larger, than Merck's. Just FYI -- of course, do your own diligence here -- but know that I've been a bear on Merck for quite a while. For 2013, I am now a bull.


Condor said...

Okay -- let's set a marker, to get specific:

On Friday, Merck closed at $45.99 on the NYSE.

So let's call that $46.

My predicition is that, on average, over all the trading days in the month of December 2013 (weighted for daily trading volumes, of course), Merck will have acheived a price in excess of $48.75.

That much seems like a lay-up, on the financial levers alone. So, it could be better than that -- but I highly doubt it will be worse than that.

That's as granular As I can get, with confidence here at mid-May 2013. [TO be complete, this prediction also appears on the immediately prior post -- where I noted the debt underwriters' conflicts of interest.]


condor said...

It ended 2013 at $49.68 -- so a buck better than I guessed.

Smile. Just about four years late mentioning it, that's all.