Bayer AG Market Cap (09/05/2014): $115.17bn
Merck & Co., Inc. Market Cap (09/05/2014): $161.23bn

On May 6th, Bayer announced the acquisition of Merck’s consumer care business for a hefty $14.2bn, surpassing competing offers from Boehringer-Ingelheim and Reckitt Benckiser and, thus becoming the second largest company in over-the-counter (OTC) products worldwide.

Bayer’s recent deal is part of the global trend of mergers and acquisitions in the pharmaceutical industry. Global pharmaceutical companies are currently narrowing their focus to business sectors in which they possess the expertise to accelerate future sales growth. However, this strategy carries a certain level of risk, industry experts say, making companies less diversified and more exposed to setbacks in their chosen areas of concentration.

Bayer AG is a 150 years-old pharmaceutical and chemical enterprise specializing in healthcare products, agriculture products and hi-tech polymer materials. In 2013 Bayer, employing 113,200 people, recorded an impressive rise in its year-on-year net income, which rose by 32.7% to $4.4bn, relative to $55.5bn in sales. Bayer’s bid for Merck is just the most recent step in the company’s pharmaceutical division’s acquisition history: the group bought Schering AG for $17bn in 2006, which remains the group’s largest deal to date. Overall, the acquisition of Merck Consumer Care perfectly fits Bayer’s strategy to strengthen its healthcare division since the target company developed leading brands such as Claritin, Coppertone and Dr. Scholl’s.

Merck & Co., Inc. is a leading American pharmaceutical company based in New Jersey. In November 2009, Merck merged with competitor Schering-Plough in a $41bn deal to diversify its business in aftermath of the American recession and shore up its business given the uncertain prospective in the healthcare industry growth. The American company managed to achieve consistent results registering $4.5bn in net income in 2013. However, facing the expiry of a number of patents for key drugs, Merck decided to focus on R&D and core-business areas, cutting jobs and selling non-strategic units, such as the OTC healthcare division.

The $14.2bn acquisition represents a 2013 pro-forma EBITDA multiple of 21x, and it allows Bayer to become the number two global company in non-prescription products, behind Johnson & Johnson and ahead of GlaxoSmithKline. Bayer expects cost synergies of about $200m per year by 2017 and also announced consistent expected revenue synergies of $400m per year starting in 2017 by selling more of Merck’s products outside the US, given Bayer’s global presence. In addition, Bayer anticipates tax savings thanks to high amortization costs over the coming years. Furthermore, as Bayer CEO Dr. Marjin Dekker pointed out, this acquisition will consolidate Bayer as the over-the-counter leader in North America and Latin America, while also increasing its global market share in key OTC product categories.

Bayer will pay the full amount of $14.2bn in cash. Furthermore, Merck and Bayer also agreed to form a collaboration to co-develop and market certain prescription heart drugs for which Merck will pay Bayer $1 billion upfront, plus potential additional milestone payments of up to $1.2 billion if sales goals are reached. With the closing of the deal expected in the second half of 2014, Bayer plans to finance the acquisition with a bridge facility provided by Bank of America Merrill Lynch, BNP Paribas and Mizuho.

Regardless of Bayer’s optimism regarding the combination, a low proportion of the expected synergies are reliable cost synergies ($200mn), while revenue synergies ($400mn) and tax synergies (undisclosed amount) will require a substantial degree of post-deal commitment
and possibly luck in order to be realized. It is then likely that Bayer has overpaid for its target, at roughly 12x pro-forma post-synergies EBITDA, assuming they are all realized. It is also troubling that despite the high amount of value derived from uncertain synergies, Bayer has paid the entire price in cash, assuming the entire risk of synergy realization.

Merck retained Morgan Stanley and JPMorgan as advisers, while Bayer relied on expertise from Bank of America Merrill Lynch.

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