Merck KGAA's Hostile Bid Catalyzes Bayer-Schering Combo

In March 2006, Bayer AG's €16.3 billion ($19.6 billion) cash offer for Schering trumped compatriot Merck KGAA's unsolicited €14.6 billion takeover bid for the specialist pharma marketer. The offers to acquire Schering put a spotlight on Europe's mid-sized players, most of which are either on the acquisition trail or putting up For Sale signs in front of corporate headquarters.

Schering AG CEO Hubertus Erlen, PhD, has long espoused the value of franchise building and specialist marketing. (See "Schering: Addressing the Specialist Challenge," IN VIVO, November 2004 (Also see "Schering: Addressing the Specialist Challenge" - In Vivo, 1 Nov, 2004.).) Now he can finally put a number on that value: about $20 billion.

In March 2006, Bayer AG 's €16.3 billion ($19.6 billion) cash offer for Schering trumped compatriot Merck KGAA 's unsolicited €14.6 billion takeover bid for the specialist pharma marketer. [See Deal][See Deal] The combined company, to be called Bayer-Schering Pharmaceuticals, will operate as an independent specialty pharma division of Bayer HealthCare AG and will focus on oncology, gynecology, and cardiology/hematology; combined sales of the two pharma companies exceeded €9 billion in 2005. Bayer is financing the deal through a combination of existing cash, the sale of several profitable materials sciences businesses (HC Starck and Wolff Walsrode), funds raised from the sale of up to €4 billion in equity, and the sale of debt.

The Bayer-Schering combination, quickly endorsed by Schering management and the company's supervisory board (despite management's emphatic protestations in response to Merck's offer that the company would generate better shareholder returns on its own than if it "cooperated with others"), seems to be a done deal. When the Merck bid became public, Schering shares quickly surpassed the €77 per share offer spurred by Schering's indignant negative response and speculation that Merck would sweeten the deal or a third party would enter the bidding. Though once Bayer's €86 per share offer emerged, Merck quickly declined to up its original terms.

The offers to acquire Schering put a spotlight on Europe's mid-sized players, most of which are either on the acquisition trail or putting up For Sale signs in front of corporate headquarters. Speculation that German political support would have been forthcoming for a Merck-Schering combination despite thousands of potential layoffs in acutely labor-sensitive Western Europe reflects the widespread belief that Germany wants to play catch-up in the global pharmaceutical arena. That speculation echoed reality in France, where in 2004 Sanofi was able to takeover the Franco-German Aventis, forming the French so-called national champion Sanofi-Aventis , now the world's third largest pharma by sales. [See Deal] (See "The Best Defense is a Good Offense: Sanofi's Bid for Aventis," IN VIVO, February 2004 (Also see "The Best Defense Is a Good Offense: Sanofi's Bid for Aventis" - In Vivo, 1 Feb, 2004.).)

That said, Merck's initial hostile move on Schering was unexpected, primarily because hostile takeovers have been unheard of in Germany's mid-sized pharmaceutical industry. The bid allowed Bayer, in theory a better fit for Schering because of the two firms' specialist marketing strategies, to play the white knight and catalyzed the Bayer-Schering combination: observers note it's unlikely that the staunchly independent Schering would have entertained the offer had it not been backed into a corner by Merck. In fact, says one executive close to the firms, Bayer has been pursuing a merger with Schering for more than a decade, thus far to no avail.

While some analysts called the opportunistic bid expensive and questioned whether even the combined entity will have the critical mass necessary in R&D to compete on a global scale, Bayer countered that the deal would unite complementary oncology businesses and result in cost savings of €700 million per year from the third year of completion. In particular, noted Bayer chairman Werner Wenning, the combination would quickly drive sales of its recently launched advanced renal cell carcinoma drug sorafenib (Nexavar) in the US, which was developed and will be sold with Onyx Pharmaceuticals Inc. [See Deal] Nexavar, at the time the first new drug approved in RCC for more than a decade and a drug which Bayer says has blockbuster potential, will be able to rely on Schering's existing US sales and marketing infrastructure, says Wenning, allowing for faster market penetration and better support as it competes with Pfizer Inc. 's sunitinib (Sutent), approved after a lightning-fast four month review one month after Nexavar.

Few argue that Germany's handful of midsized pharmaceutical companies wouldn't benefit from a round of consolidation. The nation's drugmakers have for the most part eschewed large-scale combinations as much of the industry, particularly in the US, pursued M&A to the point where even a combined Bayer and Schering would rank only 12th in terms of global health care sales.

Merck KGAA clearly felt it would benefit by bulking up and finding assets to complement its share of the colorectal cancer therapy cetuximab (Erbitux). (See "Merck: Exploiting Erbitux," In Vivo Europe Rx, July 2002 (Also see "Merck: Exploiting Erbitux" - In Vivo, 1 Jul, 2002.).) Meanwhile Altana AG only last year opted to split its pharmaceuticals and chemicals divisions sometime in 2006. Though some analysts had been clamoring for such a move for years—a noise echoed across Europe at many of the continent's conglomerates by those who maintained that pure play pharma businesses provide higher valuations—at Altana the move was ill timed. Each of its two lead respiratory products has disappointed: asthma drug ciclesonide (Alvesco) has endured a luke-warm launch at best in Europe and the first-in-class COPD treatment roflumilast (Daxas) stumbled at the last clinical hurdle, resulting in partner Pfizer bailing from the companies co-development and commercialization agreement. [See Deal] (See "Will Pharma Split Spur Altana into Action?" IN VIVO, October 2005 (Also see "Will Pharma Split Spur Altana Into Action?" - In Vivo, 1 Oct, 2005.).) New, external assets may be needed to keep the firm on course.

This perceived lack of critical mass is hardly a German phenomenon: further afield, Swiss Serono SA has seemingly decided that its days as Europe's largest independent biotechnology player are numbered. A strategic review headed by Goldman Sachs left the firm on the block but no bidder appeared despite rumors of GlaxoSmithKline PLC 's and Novartis AG 's interest. Serono is apparently back at the drawing-board and interested in the type of transforming merger or acquisition that analysts have long been suggesting would buoy the company.

Bayer has been there. Shortly after it was forced to withdraw cerivastatin (Baycol) from the market in 2001 and then lost exclusivity on its broad-spectrum antibiotic ciprofloxacin (Cipro), the group tried and failed to find a junior partner for its once-dominant pharmaceuticals business. The loss of these two blockbusters and the underperformance of its new erectile dysfunction drug vardenafil (Levitra) chased Bayer from primary care, and the company has since embraced the role of specialist marketer—not that it had much of a choice. Oncology, seemingly the cornerstone of every successful specialist, became a primary focus, and a continued emphasis on cardiovascular products skewed toward in-licensing and life-cycle management.

Geographically the firm is staying closer to home; Bayer tapped Schering-Plough Corp. to sell its remaining portfolio of primary care products in the US [See Deal] and it seems content to play outside the 50 states; earlier this year Bayer licensed ex-US rights to alfimeprase, the Phase III clot-buster from Nuvelo Inc. for $50 million up-front and up to $335 million in milestones. [See Deal] Beyond pharmaceuticals, Bayer is also bulking up on the OTC front, most significantly through the $3 billion acquisition of Roche 's Roche Consumer Health in 2004. [See Deal] (See "The Anti-Global, Specialist Strategy: Why Bayer's Choice Might Be Right for Other Pharmas," IN VIVO, January 2005 (Also see "The Anti-Global, Specialist Strategy: Why Bayer's Choice Might Be Right for Other Pharmas " - In Vivo, 1 Jan, 2005.) and "Bayer Wins Specialty CV Deal," IN VIVO, February 2006 (Also see "Bayer Wins Specialty CV Deal" - In Vivo, 1 Feb, 2006.).)

Few analysts anticipated the move to bulk up in pharmaceuticals, assuming Bayer would more likely continue to grow its OTC business, perhaps by bidding for Pfizer's OTC unit, which is reportedly on the partnering block. But Wenning maintained the move strengthened the firm's health care business and that it was "completely in line with Bayer's strategy." Success in the oncology marketplace is likely to be key to Bayer-Schering's success. Nexavar is in several Phase II and Phase III trials for various tumor types though Schering's oncology prospects took a hit in 2005 when its oral angiogenesis inhibitor PTK/ZK, developed with Novartis, was delayed after equivocal Phase III results in colorectal cancer. [See Deal] In-licensing is likely to continue as the combined firms' pipeline, boasting 19 Phase III and 14 Phase II projects, is nevertheless dominated by new dosage forms and additional indications for already marketed or late-stage clinical assets.

Not too many years ago, Bayer was the world's number one drug company. While its recent reincarnation—steered by its relatively new American-style (albeit Scottish) pharma CEO Arthur Higgins—has created one of the larger specialist-focused companies, the trouble is many even larger companies are also dedicating themselves to specialist strategies--like Roche and Bristol-Myers Squibb Co. And virtually all Big Pharmas nowadays have major specialist businesses—Pfizer has said that oncology will be its second largest therapeutic area in terms of sales, for example. It also has a major ophthalmology program and has bulked up in acute-care hospital anti-infectives.

Bayer's advantage therefore cannot be its size—it will have to be its relative nimbleness. But Bayer has never been particularly nimble. It remains to be seen whether Higgins and his colleagues can make it so even as they've made the company substantially larger and—given the integration tasks ahead—more complex.