The Future of the Merck and Schering-Plough Merger

by Marta Kowalczyk March 19 2009, 16:18

I. Introduction

On March 9, 2009 Merck Co., Inc. ("Merck") and Schering-Plough Corporation ("Schering-Plough") announced that a merger agreement had been unanimously approved by each corporation's Board of Directors [1] and is worth $41.1 billion dollars. [2] Furthermore, the merger of these two pharmaceutical giants is expected to increase efficiencies and result in cost savings of approximately $3.5 billion annually. [3] This merger agreement is constructed as a reverse merger, under which Merck and Schering-Plough will merge, under the name Merck. [4] The purpose of the unusual manner of the merger is to ensure that Schering-Plough's joint venture agreement involving Remicade with Johnson & Johnson is not terminated. [5] This article discusses the uniqueness of the reverse merger. Part II analyzes the structure of the reverse merger and the purpose of the merger. Part III evaluates the advantages and disadvantages of the merger of these two pharmaceutical companies. Part IV concludes that the merger of the two pharmaceutical giants is beneficial and that the drug rights to Remicade will not be lost.

 II. Background

In its merger, Merck and Schering-Plough devised a unique reverse merger. In the following section, the reverse merger will be analyzed to determine its structure and purpose.

A. Structure of the Reverse Merger

Under the Merck and Schering-Plough reverse merger, although Merck is the larger corporation, Schering-Plough will be "acquiring" Merck. Schering-Plough will form two subsidiaries (subsidiary 1 and subsidiary 2) in order to complete the reverse merger. [6] Schering-Plough will move $10 billion into subsidiary 1 and 1.5 billion shares into subsidiary 2. Subsidiary 1 will merge with and into Schering-Plough, paying its shareholders $10.50 in cash and 0.5767 of a share of Schering-Plough. [7] Finally, Merck will merge with subsidiary 2. [8] Each stock of Merck will be converted into a stock of Schering-Plough. [9] Thus, Merck will be a wholly-owned subsidiary of Schering-Plough, but Schering-Plough will take the name of Merck. [10] In other words, on paper a subsidiary of Schering-Plough will be acquiring Merck. In reality, Merck will be acquiring Schering-Plough.

B. Why a Reverse Merger?

Schering-Plough and Johnson & Johnson have a joint venture agreement on the marketing of Remicade, a drug for the treatment of rheumatoid arthritis. [11] Under the joint venture Schering-Plough has overseas rights to market Remicade while Johnson & Johnson markets the drug in the United States. [12] Remicade is a very profitable venture for Schering-Plough. In 2008 it represented $2.1 billion in sales revenue for Schering-Plough. [13] A termination clause exists within the joint venture agreement stipulating that rights to Remicade would revert to Johnson & Johnson if change in control of Schering-Plough occurs. [14] As a result, potentially Merck and Schering-Plough could lose $2.1 billion annually as a result of the merger. [15] Therefore, Schering-Plough and Merck devised an unusual merger strategy so that ownership of Schering-Plough does not theoretically change hands. Instead, under the reverse merger a subsidiary of Schering-Plough will be acquiring Merck and thus, bypass the change of control clause.

III. Benefits and Costs of the Merger

Benefits from the merger include large annual savings, [16] an increase in presence abroad, [17] and complementary product portfolios. [18] As mentioned previously, the Merck and Schering-Plough merger will result in $3.5 billion in annual savings. [19] Furthermore, the deal would increase Merck's presence abroad as 70% of Schering-Plough's revenues are made overseas. [20] In addition, Merck and Schering-Plough have complementary product portfolios and both focus on "biologics." [21] Also, the combined entity would have a more diverse portfolio in the therapeutic areas of cardiovascular, respiratory, oncology, neuroscience, infectious disease, immunology, and women's health. [22] Finally, the transaction would double the number of Merck's potential medicines. [23]

There are costs to this transaction as well: job reductions [24] and the potential loss of rights to Remicade. [25] Although both companies have already announced job cuts last fall, the merger will result in even greater job reductions as the surviving entity will consolidate the two pharmaceutical corporations and cut down on labor costs. [26] According to the Dow Jones Newswires, Merck expects to reduce about 15% of its work force. [27] Also, Remicade drug rights may be lost to Merck. [28] Even though the reverse merger technically bypasses the change of control clause to protect the arthritis drug, Johnson & Johnson could litigate this matter. [29] If Merck does lose Remicade, this would result in a nearly $2 billion loss annually. [30]

IV. Conclusion

Ther merger between Merck and Schering-Plough is beneficial. First, both corporations complement each other through their medicinal product portfolios and therapeutic areas. Second, this deal will result in billions in annual savings for the merged entity. Although job reductions will result, this had already been expected last fall. Finally, most likely drug rights to Remicade will not be lost to Johnson & Johnson because the structure of the reverse merger bypasses the change of control clause. Therefore, Johnson & Johnson cannot terminate the joint venture. Even if Johnson & Johnson does choose to litigate the matter in court, the courts have consistently focused on the form of the merger and not the spirit of the transaction. [31] As a result, most likely if the matter is litigated, the courts will recognize the reverse merger and hold that the change of control clause was not triggered. Therefore, the merger is advantageous.

 


[1] Press Release, Merck & Co., Inc, Merck and Schering-Plough to Merge, Mar. 9, 2009.
[2] Val Brickates Kennedy & Aude Lagorce, Merck to Buy Schering Plough for $41.1 Billion, Market Watch, Mar. 9, 2009, http://www.marketwatch.com/News/Story/merck-makes-deal-buy-schering-plough/story.aspx?guid=%7BF1E829D5%2D71C2%2D4C75%2D8909%2DAF041CF4F141%7D.
[3] Press Release, Merck Co., Inc, supra note 1.
[4] Id.
[5] Val Brickates Kennedy, Could Derail Merck, Schering-Plough Merger?, Market Watch, Mar. 9, 2009, http://www.marketwatch.com/news/story/could-jj-derail-merck-schering-plough/story.aspx?guid={870A9DE6-E22F-415D-8C9B-60C1CA97FC06}&dist=SecMKTW.
[6] Robert Willens, Merck’s “Unusual” Deal Moves Beyond Taxes, CFO, Mar. 16, 2009, http://www.cfo.com/article.cfm/13312058/1/c_2984354?f=rsspage.
[7] Id.
[8] Id.
[9] Id.
[10] Id.
[11] Clifford Mintz, Merck-Schering Plough Under the Microscope: Why a Reverse Merger? Seeking Alpha, Mar. 12, 2009, http://seekingalpha.com/article/125504-merck-schering-plough-under-the-microscope-why-a-reverse-merger?source=financialcontent.
[13] Matthew Herper and Robert Langreth, Battle Signs: Merck and J&J?, Forbes, Mar. 9, 2009, http://www.forbes.com/2009/03/09/merck-schering-merger-business-health-care-merger.html.
[14]  Mintz, supra note 10; Kennedy supra note 5.
[15] Herper and Langreth, supra note 12.
[16] Press Release, supra note 1.
[17] Kennedy & Lagorce, supra note 2.
[18] Press Release, supra note 1.
[19] Id.
[20] Kennedy & Lagorce, supra note 2.
[21] Id. Press Release, supra note  1.
[22] Id.
[23] Id.
[24] Kennedy  & Lagorce, supra note 2.
[25] Id. Herper and Langreth, supra note 12.
[26] Kennedy  & Lagorce, supra note 2.
[27] Id.
[28] Id. Herper and Langreth, supra note 12.
[29] Id.
[30] Id.
[31] See Terry v. Penn Central, 668 F.2d 188 (3d Cir. 1981); Hariton v. Arco Electronics, Inc., 188 A.2d 123 (Del. 1963).
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