Schering’s Buy of Organon Should be a Win-Win for SGP, Akzo Nobel

Schering-Plough made a move that looks to shore up their pharmaceutical business with one broad stroke, agreeing to acquire Dutch firm Akzo Nobel’s (ADR; AKZOY) Organon BioSciences drug segment for roughly 11b euro, or $14.4 billion USD based on current rates. 

News on the deal sent Akzo’s shares skyrocketing (today up 15% to $70 and change), as the company planned on floating Organon business as an IPO later this month, but expectations were only for a value of $11-12 billion on the stand-alone entity, 22% less than Schering’s offer. 

Even with the premium factored in, Schering seems to have gotten a solid business at a fair price of just under 3x sales (based on 2006 revenue).  Industry average multiples for big pharma are currently in the range of 3.3 – 3.6x sales, and we are still in a historical trough in terms of valuations across the sector.  There are broad-based reasons for this, but on the whole the deal seems like a win-win for both companies.  Akzo doesn’t have to float a new drug stock at a time when the IPO markets are weakening and pharma is generally out of favor.  Schering, meanwhile, shores up their potentially disastrous pipeline issues, picking up 5 drugs in Phase III testing. 

If Schering hadn’t made a move soon to beef up their pipeline, their existing debt would have come under pressure in the next year or two as earnings visibility faded away.  By diversifying their product mix away from risky cholesterol drugs (who doesn’t have a cholesterol drug on the market these days?), Schering can probably sustain investment-grade ratings for the new debt that will have to be added to finance the deal.

The exact details of the financing are not yet known, as to how much debt will be used versus equity and cash.  We do know that as of 12/31/06, Schering’s current account surplus was a little over $6 billion.  We also know that the company is only forecasting an increase of $.10/share to net income during the first year Organon’s results are included.  Based on Organon’s operating profits for 2006, it looks as though Schering will be issuing between 400-500m shares to finance the bulk of the deal, or roughly $8 billion, and will add about $2 b in long-term debt to fill in the remainder. 

We discussed the break-up value of Schering-Plough in depth back on Februrary 1^st (http://a673b.bigscoots-temp.com/2007/02/247_wall_st_200.html), and noticed that the $25 price the stock was then trading was an 18% discount to our assessment of the sum of its parts.  Today SGP stock is basically flat on the acquisition news, trading down 10 cents at $23.75, having trended down slightly since our break-up value piece ran.  In our break-up analysis we assessed the pharma business of Schering at exactly 3x sales, so considering the improved pipeline prospects at Organon, it definitely appears that Schering didn’t “buy up” for this deal, and has made an additive purchase. 

Ryan Barnes

March 12, 2007