Marcial: Why Schering-Plough Is Alluring

Global pharmaceutical company Schering-Plough (SGP) has taken wing since Oct. 27, when its stock traded at a 52-week low of 12 a share. Some analysts expect the stock, now at 18, to fly even higher.

One reason: positive earnings news. The company's profits have been steadily rising in the past five years. On Feb. 3, Schering reported fourth-quarter diluted profits that beat analysts' expectations—39¢ a share vs. the Wall Street consensus forecast of 30¢ and year-ago profits of 27¢. Another positive: Schering's relatively robust pipeline of new drug prospects. The company's well-stocked cupboard is raising investor hopes that a blockbuster drug or two may be in the making.

But what's really catching investor attention these days: fresh speculation that Schering may become the next pharmaceutical takeover candidate after Pfizer's (PFE) acquisition of Wyeth (WYE) in January.

A Buyout Target?

Analysts who are aware of such a possibility, including health-care analyst Dr. Timothy Anderson of Sanford C. Bernstein (AB), don't think that such a deal is in the offing yet. Nonetheless, the idea has gained some currency on the Street, even though a takeover could be complicated by a joint venture Schering has with Merck (MRK) for the sale of two cholesterol drugs.

"There is a possibility that Schering-Plough will be acquired," says Anderson. "However, because of prior business arrangements, this may only occur if Johnson & Johnson (JNJ) and Merck were able to split up the company," says Anderson, with Merck buying out Schering's cholesterol-lowering drugs,

Through its joint venture with Merck, Schering gets part of the profits from two cholesterol drugs, Zetia and Vytorin. Zetia is a lipid-lowering agent that blocks the absorption of cholesterol in the intestine. Vytorin is a combination of Zetia and Merck's Zocor statin cholesterol agent. Schering took in profits of $2 billion in 2007 from the joint venture.

Even with these links, or maybe because of them, it's possible that J&J may bid outright to buy Schering, figures Anderson, who believes Schering could fetch a bid price higher than the targets (ranging from 20 to 23) that analysts have for the stock. In such an event, J&J may have to sell Schering's share of the cholesterol drug joint venture to Merck.

Promising Pipeline

Anderson recalls that Schering Chairman and CEO Fred Hassan was the CEO of Pharmacia when he sold the company to Pfizer in 2003. Right after that deal Hassan joined Schering. "Who knows, he might just do the same thing again and sell Schering," says Anderson, who rates Schering a buy. He expects to raise his price target of 20 because of the "positive" fourth-quarter results. Schering has several compelling investment attributes, says Anderson, including low exposure to competition from generic drugmakers through 2015 because few of its patents are set to expire before then.

George Rho of investment research outfit Value Line (VALU) is also bullish on Schering: "We like these shares for both the short term and the long haul," he says. "Year-over-year bottom line comparisons have been positive for 15 straight quarters," he notes. The stock is favorably ranked for the year ahead, he adds. "Looking out to 2011-2013, we think the [drug] pipeline will help fuel an increase in earnings" and an expanded price-earnings multiple, currently at 10 based on 2008 earnings of $1.75 a share.

He notes that Schering's drug pipeline includes 46 products in various stages of clinical development. Nineteen are in phase I clinical trials, 15 in phase II, 11 in phase III, and three in preregistration. Among the most interesting late-stage compounds, says Rho, are TRA for anti-clotting, Simponi for rheumatoid arthritis, Boceprevir for hepatitis C, Bridion for use in anesthesia, and Saphris for schizophrenia.

If all goes according to plan, says Rho, all five products could be launched in the U.S. within five years, each drug potentially hitting $1 billion in sales.

ValuEngine, an independent research outfit, rates Schering a buy and expects it to outperform the market this year. "Based on available data as of Jan. 15, we believe that Schering should be trading at 26.19 a share," says the firm in a report.

Based on Schering's strong showing in the fourth quarter, analysts may be raising their sales and earnings projections and price targets, which surely should help buoy the stock price.

Both Schering spokesman Steve Galpin Jr. and J&J's Jeffrey Leebaw declined to comment on the takeover speculation. And so did Merck spokeswoman Amy Rose. But she noted that Merck CEO Richard Clark did address analysts' questions about the company's general acquisition strategy during a conference call about fourth-quarter results. "I wouldn't rule out anything&there are opportunities across the whole spectrum that we consider, and the critical point again is [that] the transaction has the financials to deliver value to our shareholders," said Clark.

So while the Merck chief didn't specifically mention Schering as an opportunity, it's clear that large drug outfits could be on the acquisition hunt in 2009. Stay tuned.

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