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Merck Seen Unlocking $13 Billion With Breakup: Real M&A

Merck & Co. Facility in Summit, New Jersey
Shares of Merck have trailed every other large drugmaker in the past 12 months and underperformed the Standard & Poor’s 500 Health Care Index since 2010, according to data compiled by Bloomberg. Photographer: Emile Wamsteker/Bloomberg

Merck & Co., the second-biggest U.S. drugmaker, may be coming around to the idea of separating its businesses after the breakup of larger rival Pfizer Inc. boosted shareholder value by $50 billion.

Merck Chairman and Chief Executive Officer Ken Frazier said last week that he’s evaluating whether the animal-health unit and consumer products would be better off outside the $134 billion company. Slimming down to focus on human medicines would follow in the footsteps of Pfizer, which spun off its animal-health unit and sold its baby formula business. Novartis AG also has identified its animal-health division as a top candidate to sell, Bloomberg News reported yesterday.

Shares of Merck have trailed every other large drugmaker in the past 12 months and underperformed the Standard & Poor’s 500 Health Care Index since 2010, according to data compiled by Bloomberg. The Whitehouse Station, New Jersey-based company is firing 20 percent of its workers and grappling with declining sales and setbacks on experimental medicines. As some rivals boost investor returns through spinoffs and unit sales, Goldman Sachs Group Inc. estimates that there’s almost $13 billion of unrealized value within Merck’s conglomerate structure.

“You have a road map laid out by Pfizer,” said David Heupel, a Minneapolis-based fund manager at Thrivent Financial for Lutherans, which oversees $12 billion in equity assets including Merck shares. “You don’t have to be the first company to go down that path and hope that it creates value because we have some proof that it does.”

Portfolio Evaluation

Medicines for animals, such as antibiotics and vaccines, generated $3.4 billion of sales last year, 7.2 percent of Merck’s $47 billion of total revenue. Consumer-care products, such as Coppertone suntan lotion, Claritin allergy medicine and the Dr. Scholl’s foot-care line, had $1.95 billion of sales.

Merck is evaluating those units to determine whether they “produce the most value inside our portfolio or outside our portfolio,” Frazier, who has been CEO of Merck since January 2011, said on an earnings conference call Oct. 28.

“We continue to evaluate all of our businesses -- including Animal Health and Consumer Care -- and currently view them as important components of our diverse portfolio, contributing both top and bottom line growth,” Steve Cragle, a spokesman for Merck, said in an e-mail yesterday. “If we were to view them as being more productive outside of Merck, we would consider alternatives.”

Pfizer Breakup

Pfizer sold its infant-nutrition business to Nestle SA for $11.9 billion in 2012, and then this year spun off its animal-health unit as a separate publicly traded company called Zoetis Inc. Pfizer stockholders received shares of Zoetis.

Since first announcing the sale to Nestle, Pfizer’s market value has climbed by about $37 billion, data compiled by Bloomberg show. Including Zoetis’s current $16 billion market value, that’s a $53 billion increase for Pfizer shareholders.

Bristol-Myers Squibb Co. decided to become a pure-play drugmaker by spinning off its baby-formula business, Mead Johnson Nutrition Co., in 2009. Abbott Laboratories also split off AbbVie Inc. less than a year ago to separate its non-pharmaceutical businesses from its best-selling arthritis drug Humira.

Novartis, Europe’s biggest drugmaker by sales, is working with Goldman Sachs on a portfolio review, according to people familiar with the matter, who asked not to be named because the process is confidential. In addition to animal health, the $208 billion company is also considering selling its over-the-counter medicines unit and the vaccines operation, they said this week.

‘Intense’ Pressure

While Pfizer, Bristol-Myers and Novartis gained at least 22 percent in the past year, Merck has fallen 0.6 percent, making it the worst performing large pharmaceutical stock, data compiled by Bloomberg show.

“Merck management is responding to intense shareholder pressure,” Mark Schoenebaum, a New York-based analyst at International Strategy & Investment Group LLC, said in an e-mail yesterday. Like Pfizer’s Zoetis, Merck’s animal-health business “could definitely stand on its own.”

The unit is tucked inside a company that’s valued at 9.8 times its trailing 12-month earnings before interest, taxes, depreciation and amortization, data compiled by Bloomberg show. Zoetis fetches twice that.

Value Potential

“Merck has pretty attractive assets in its consumer and animal-health businesses,” Heupel of Thrivent said in a phone interview. “We’re comfortable in the belief that they would be worth more spun off, sold or divested than under Merck right now.”

When valuing Merck’s units separately, they add up to $50 a share, according to Jami Rubin, a New York-based analyst at Goldman Sachs. With the stock at $45.72 yesterday, her estimate implies about $12.5 billion of value could be unlocked by breaking the company into pieces.

Today, Merck shares fell 0.8 percent to $45.36.

The downside to selling or spinning off assets is that Merck would be giving up cash flow at a time when its core drug business faces challenges, Rubin wrote in an Oct. 29 report. Sales of its best-selling product, diabetes pill Januvia, fell 5 percent in the third quarter.

Merck’s “management sounds like it will execute a deal soon,” such as divesting the animal-health or consumer units, or making an acquisition in oncology, Alex Arfaei, a New York-based analyst at Bank of Montreal, wrote in an Oct. 28 report.

Acquisition Money

Valeant Pharmaceuticals International Inc., the most acquisitive health-care company in the past three years, could buy some of Merck’s products in emerging markets or the company’s consumer products to complement its own over-the-counter business, Arfaei said.

Laurie Little, a spokeswoman for Laval, Quebec-based Valeant, didn’t respond to a phone call or e-mail seeking comment.

Merck could use the money from a unit sale to acquire or partner with a growing biotechnology company focused on human health care, said Herman Saftlas, a New York-based equity analyst at Standard & Poor’s. That said, Merck seems less willing to part with some of its smaller businesses than Pfizer was, he said.

“It’s on the table, but whether it’s going to happen, I have high doubts,” Safltas said in a phone interview. “Pfizer was planning this for many years and sliced and diced the company very carefully into different portions that could be easily siphoned off. As far as Merck, this is the first time we’re hearing about something like this.”

While Merck may be able to unlock as much value by driving sales growth of Januvia and better developing its pipeline, the company may be pushed to drive value faster, said Vamil Divan, a New York-based analyst at Credit Suisse Group AG.

Streamlining operations “is the focus of the whole industry right now,” Divan said in a phone interview. “Frazier’s under pressure to get the stock working again, so he has to be more open to these ideas.”

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