The Acquisition Between Merck and Schering-Plough

On March 9, 2009, Merck & Co., Inc. and Schering-Plough Corporation announced that their Boards of Directors have unanimously approved a definitive merger agreement under which Merck and Schering-Plough will combine, under the name Merck in a stock and cash transaction. As the two companies’ combined 2008 revenues were $47 billion. The deal officially closed on November 3, 2009.
Background of the two parties
Merck & Co. (NYSE: MRK) was initially formed in 1891 as a United States subsidiary of the German chemicals and pharmaceutical company Merck KGaA. During World War I, it was established as an independent company from confiscated assets. Since then, it has grown to become one of the top seven largest pharmaceutical and biotech companies worldwide.

Schering-Plough (NYSE: SGP) is one of the medium-sized players in the pharmaceutical industry, with sales of $18.5 billion in 2008. Its two largest products are autoimmune medication Remicade, sold internationally, and Zetia & Vytorin, a joint venture taken with Merck that fights cholesterol. While growth of Remicade has been strong, Vytorin has taken a hit after studies questioned its efficacy compared to the older drug it is based on and in treating blockage of the heart valve.
The process of the acquisition
The Merck and Schering-Plough took the typical reverse merger arrangement during the acquisition process.
The Merck- Schering-Plough merger agreement contemplates a two-step transaction involving Merck, Schering-Plough, and Schering’s two special purpose, subsidiary holding companies, Blue, Inc. and Purple, Inc. In step one of the mergers, Blue will merge into Schering-Plough and each share of Schering-Plough will be converted into the right to receive (i) 0.5767 shares of the surviving Schering-Plough and (ii) $10.50 in cash. In step two of the merger, Purple will merge into Merck and each share of Merck will be converted into 1 share of the surviving Schering-Plough.
After the completion of these two steps, the surviving Merck will be a wholly owned subsidiary of the surviving Schering-Plough. Yet, the shareholders of pre-merger Merck will own approximately 68% of the surviving Schering-Plough and shareholders of pre-merger Schering-Plough will own around 32% of the surviving Schering-Plough. Although Merck will become a subsidiary of Schering-Plough Merck’s pre-merger shareholders will together possess a majority of the voting and economic rights (or beneficial ownership) of Merck’s new parent company, Schering-Plough.
One peculiarity of the Merck-Schering reverse merger transaction structure is that between steps one and two Merck finds itself in a slightly precarious situation. After the completion of step one, Schering’s pre-merger shareholders will have received shares of the surviving Schering-Plough and a cash payout, but Merck’s pre-merger shareholders will not yet have seized control over the management of the surviving Schering-Plough.
The merger agreement has come up with a way to protect Merck’s shareholders during this governance gap. Simultaneously with the completion of step one of the merger, Schering has agreed that its board will cause all of its directors (other than 3 specified exceptions) to resign and to elect the members of pre-merger Merck’s board of directors as the directors of the surviving Schering corporation. Even before pre-merger Merck’s shareholders acquire their supermajority share of the beneficial ownership of the surviving Schering corporation after step two, they indirectly will have already taken the helm of the surviving Schering corporation through the election of their own directors to the new parent company’s board.
The motivation of the acquisition
Merck faces many of the challenges that face all pharmaceutical companies, including issues surrounding patent expiration and FDA approval. Patent expiration may affect 30% of sales through 2008. In addition, there is growing pressure in the US and abroad to lower the price of medication.
Schering-Plough has a particularly small pipeline, with very few drugs currently in development. In the near term, it does however have one of the safest profiles in the industry, with very few major patents coming up for expiration in the coming years.
The newest merger will result in a strengthened product pipeline in areas such as cardiovascular and respiratory disease and oncology, and should eventually yield $3.5 billion annually in cost savings. Merck is also set to be hit by patent expiries of some of its top sellers in the next decade, while Schering-Plough is not.

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