the merger the upjohn – pharmacia case
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THE MERGER The Upjohn – Pharmacia Case. John Spiteri & Raj Joshi June 17, 2006. MERGERS & ACQUISITIONS. Motivation Factors for M&A. Take advantage of ‘economies of scale’ Improve ‘target management’ Combine ‘complementary resources’ Capture ‘tax benefits’ - PowerPoint PPT PresentationTRANSCRIPT
THE MERGERTHE MERGERThe Upjohn – Pharmacia CaseThe Upjohn – Pharmacia Case
John Spiteri & Raj JoshiJohn Spiteri & Raj Joshi
June 17, 2006June 17, 2006
MERGERS & ACQUISITIONSMERGERS & ACQUISITIONS
Motivation Factors for M&AMotivation Factors for M&A
Take advantage of ‘economies of scale’Take advantage of ‘economies of scale’Improve ‘target management’Improve ‘target management’Combine ‘complementary resources’Combine ‘complementary resources’Capture ‘tax benefits’Capture ‘tax benefits’Provide ‘low cost financing’ to a financially Provide ‘low cost financing’ to a financially constrained targetconstrained targetIncrease ‘product market rents’Increase ‘product market rents’
Pricing the DealPricing the Deal
Premium paidPremium paidPrice is a function of Hostile Takeover Price is a function of Hostile Takeover versus Friendly Mergerversus Friendly MergerCan the premium paid be justified (DCF or Can the premium paid be justified (DCF or DAE)DAE)Industry metrics used in pricing the dealIndustry metrics used in pricing the deal
Methods of Financing the DealMethods of Financing the Deal
CashCashSenior DebtSenior DebtMezzanine DebtMezzanine DebtCapital Markets i.e. stocks, new-issue or Capital Markets i.e. stocks, new-issue or swaps, options, warrantsswaps, options, warrants
THE 1994 THE 1994 PHARMACEUTICAL PHARMACEUTICAL
INDUSTRYINDUSTRY
1994 Pharmaceutical Industry 1994 Pharmaceutical Industry
Buyer power increasing - Hospitals, Consumers, Buyer power increasing - Hospitals, Consumers, Health Maintenance Organizations (HMOs)Health Maintenance Organizations (HMOs)HMOs & Pharmaceutical Benefit Firms (PBMs) HMOs & Pharmaceutical Benefit Firms (PBMs) demanding use of generic drugs demanding use of generic drugs General feeling is that “Bigger is Better” General feeling is that “Bigger is Better” Consolidations happening in industry 1992-1994 Consolidations happening in industry 1992-1994 $70B in M&A activity like, Merck & Company, $70B in M&A activity like, Merck & Company, Bristol-Myers Squibb and American Home Bristol-Myers Squibb and American Home ProductsProducts
1994 Pharmaceutical Industry1994 Pharmaceutical Industry
Estimated at $252B Estimated at $252B - North America $79B - North America $79B - Europe $77B - Europe $77B - Japan $49B- Japan $49BIndustry expected to grow at 6% Industry expected to grow at 6% Top 10 firms have 28% market share Top 10 firms have 28% market share Average industry expense on R&D is Average industry expense on R&D is approx. 19% of gross salesapprox. 19% of gross sales
Motivation for Consolidation in the Motivation for Consolidation in the Pharmaceutical IndustryPharmaceutical Industry
1.1. Vertical IntegrationVertical Integration
Move closer to patients by acquiring Move closer to patients by acquiring major drug buyers such as PBM’s & major drug buyers such as PBM’s & HMO’sHMO’s
Motivation for Consolidation in the Motivation for Consolidation in the Pharmaceutical IndustryPharmaceutical Industry
2.2. Horizontal IntegrationHorizontal Integration
Increasing buyer strength Increasing buyer strength Cost to develop new drugs rising Cost to develop new drugs rising Markets globalization Markets globalization Protect margins by seeking efficiency gains Protect margins by seeking efficiency gains
through economies of scale through economies of scale By product lines By product lines
THE MERGER THE MERGER
UPJOHN INC. & PHARMACIA ABUPJOHN INC. & PHARMACIA AB
Company ComparablesCompany Comparables
CATEGORY Upjohn Pharmacia
1994 Sales $3.3B $3.4B
European Sales 20% 59%
U.S. Sales 59%16%
Pacific Rim 13%
Other 8% 9%
# of Employees 16,900 18,600
Head Office Michigan Sweden
The Upjohn CompanyThe Upjohn Company
Market leader:Market leader:
Central nervous systemCentral nervous system SteroidsSteroids Anti-inflammatory & analgesicAnti-inflammatory & analgesic Reproductive & women’s healthReproductive & women’s health Critical care, transplant and cancerCritical care, transplant and cancer Infectious diseaseInfectious disease MetabolicMetabolic
The Upjohn CompanyThe Upjohn Company
Upjohn’s rationale for the proposed merger:Upjohn’s rationale for the proposed merger:
Patents expired on some of its key productsPatents expired on some of its key products Fewer products compared to the competitionFewer products compared to the competition Weak foreign salesWeak foreign sales Stock price stagnant, rumored to be a potential Stock price stagnant, rumored to be a potential
takeover targettakeover target
Pharmacia ABPharmacia AB
Market leader:Market leader:
Cancer treatmentCancer treatmentGrowth hormonesGrowth hormonesCataract surgery productsCataract surgery productsIntravenous nutritionIntravenous nutritionAllergy diagnosticsAllergy diagnosticsSmoking cessationSmoking cessation
Pharmacia ABPharmacia AB
Pharmacia’s rationale for the proposed Pharmacia’s rationale for the proposed merger:merger:
Several companies were consolidating Several companies were consolidating during this periodduring this period
Access to new marketsAccess to new marketsNo blockbuster drug in its pipelineNo blockbuster drug in its pipelineRelied on larger number of products with Relied on larger number of products with
small sales potentialsmall sales potential
Terms - Proposed MergerTerms - Proposed Merger
1 Upjohn share for 1.45 shares in the new 1 Upjohn share for 1.45 shares in the new companycompany1 Pharmacia share for 1 share in the new 1 Pharmacia share for 1 share in the new companycompanyPooling of interestsPooling of interestsPharmacia & Upjohn’s board of directors Pharmacia & Upjohn’s board of directors would be formed from an equal numberwould be formed from an equal numberCorporate head office in LondonCorporate head office in LondonOperational head office in MichiganOperational head office in Michigan
Performance Dec 31 1994Performance Dec 31 1994CATEGORY($MM) Upjohn Pharmacia COMBINED
Revenues $3,344,538 $3,478,244 $6,822,782
Net Income $489,088 $344,363 $833,451 Gross Margin 74.8% 69.9% 72% R&D $607,187
18%
$490,081
14.1%
$1,097,268
16.1% R&D %In millions
JUNE 30, 1995 JUNE 30, 1995 JUNE 30, 1995
Cash & Equiv $632,357 $1,099,070 $1,662,427 A/R $671,767 $913,046 $1,584,813 Inventory $502,172 $500,379 $1,002,551
CPTD $60,285 $700,034 $760,319 LTD $515,005 $85,508 $600,513
Ratios as at June 30, 1995Ratios as at June 30, 1995RATIOS Upjohn Pharmacia COMBINED
Working Capital $1,062,807 $1,007,367 $2,001,174
Current Ratio 2.0 1.6 1.7
Quick Ratio 1.5 1.3 1.3
TNW ($000’s) $2,277,660 $1,868,365 $4,077,025
Debt : Networth 1.2:1 0.7:1 0.9:1
A/R Turnover 2.6 2.0 2.2
A/R DOH 143 182 163
Invent Turnover 0.9 1.1 1.0
Key Valuation AssumptionsKey Valuation Assumptions
1.1. Sales is the key driver for the valuationSales is the key driver for the valuation2.2. Management believes combined sales Management believes combined sales
will exceed industry growth ratewill exceed industry growth rate3.3. Estimated $500MM in operating cost Estimated $500MM in operating cost
synergies & 85% of that being achieved synergies & 85% of that being achieved by 1996.by 1996.
4.4. No accounting issues or noiseNo accounting issues or noise
Assumptions cont’d….Assumptions cont’d….
5.5. New entity is expected to have a 50% New entity is expected to have a 50% debt & 50% equity structuredebt & 50% equity structure
6.6. Acquisition financed through stock swap, Acquisition financed through stock swap, no change in interest expense no change in interest expense
7.7. No additional stress on WC to support No additional stress on WC to support growth and R&D growth and R&D
8.8. Tax rates will approach the mean of both Tax rates will approach the mean of both at 34%at 34%
9.9. WACC = 8%WACC = 8%
Benefits of the MergerBenefits of the Merger
Merged companies more competitive due Merged companies more competitive due to economies of scaleto economies of scaleProduct mix complements each otherProduct mix complements each otherComplementary geographic positionsComplementary geographic positionsCost cutting savings expectedCost cutting savings expectedGreater marketing leverageGreater marketing leverageStronger combined R&D efforts Stronger combined R&D efforts
Class ExerciseClass ExerciseHand-out - 10 minute class exerciseHand-out - 10 minute class exercise
Discuss the factors that might affect the valuation Discuss the factors that might affect the valuation of the combined companies - RISK & MITIGANTS - of the combined companies - RISK & MITIGANTS -
THE FOUR KEY DRIVERSTHE FOUR KEY DRIVERS
1.1. Implementation Implementation 2.2. Product DevelopmentProduct Development3.3. Revenue ExpectationsRevenue Expectations4.4. SynergiesSynergies
IMPLEMENTATIONIMPLEMENTATION
RISKSRISKSLoss of focus Loss of focus No one clear leaderNo one clear leaderCompany Company environment at risk - environment at risk - operating and culturaloperating and cultural
MITIGANTSMITIGANTSHistory of acquisitions History of acquisitions & operational & operational optimizationsoptimizationsIndustry expertiseIndustry expertiseWillingness to merge Willingness to merge - Friendly- Friendly
PRODUCT DEVELOPMENTPRODUCT DEVELOPMENT
RISKSRISKSNo R&D synergy No R&D synergy realizationrealizationNo blockbuster drugsNo blockbuster drugsWeak pipelineWeak pipelineIndustry approaching $1B Industry approaching $1B a year in R&Da year in R&D
MITIGANTSMITIGANTSCombined R&D exceeds Combined R&D exceeds the $1B thresholdthe $1B thresholdVariety of drugs with high Variety of drugs with high potential of successpotential of successStrong W/C to support Strong W/C to support continued R&D continued R&D investmentsinvestmentsNew product launch – New product launch – quicker to marketquicker to market
REVENUE EXPECTATIONSREVENUE EXPECTATIONS
RISKSRISKSAnalyst project new Analyst project new company to exceed company to exceed industry growth rateindustry growth rateDowntime for sales Downtime for sales rep. trainingrep. trainingAcceptability of drugs Acceptability of drugs in new countries in new countries
MITIGANTSMITIGANTSStrong sales cultural Strong sales cultural in both companiesin both companiesEmployee expertise Employee expertise existsexistsComplementary Complementary geographical geographical strengths strengths No product No product cannibalizationcannibalization
SYNERGIESSYNERGIES
RISKSRISKSAggressive cost-Aggressive cost-cutting targetscutting targetsSG&A savings not SG&A savings not realizedrealizedTrue realization of True realization of economies of scale economies of scale not achievablenot achievable
MITIGANTSMITIGANTSReduction of labour Reduction of labour force (4000 jobs)force (4000 jobs)Stronger buying Stronger buying power for materialspower for materialsCost synergies due to Cost synergies due to reduction in SG&A, reduction in SG&A, Manufacturing Manufacturing expenses ($500M)expenses ($500M)Foreign ExchangeForeign Exchange
VALUATIONSVALUATIONS
PHARMACEUTICAL INDUSTRYPHARMACEUTICAL INDUSTRY
Pharmaceutical ValuationsPharmaceutical Valuations
Must think of the company as a collection Must think of the company as a collection of different experimental drugs that each of different experimental drugs that each have a market potentialhave a market potentialTreat each promising drug as a mini-Treat each promising drug as a mini-company within the portfoliocompany within the portfolioHow to Valuate – do a Discounted Cash How to Valuate – do a Discounted Cash Flow (DCF) on each drugFlow (DCF) on each drug
Probabilities of Success in the Probabilities of Success in the Pharmaceutical WorldPharmaceutical World
Each new drug conceived has a 1% chance of Each new drug conceived has a 1% chance of making it to the market..making it to the market..… ...therefore each drug in pre-… ...therefore each drug in pre-clinical trails are assigned zero valueclinical trails are assigned zero valueEntering Phase I trials = 15% prob. of successEntering Phase I trials = 15% prob. of successEntering Phase II trials = 30% prob. of successEntering Phase II trials = 30% prob. of successEntering Phase III trails = 60% prob. of successEntering Phase III trails = 60% prob. of successEntering FDA approval = 90% prob. of successEntering FDA approval = 90% prob. of success
The 10 Year Life Cycle of a DrugThe 10 Year Life Cycle of a Drug
5 Year Forecast5 Year Forecast1996 1997 1998 1999 2000
UpjohnSales ($MM) 3527 3622 3719 3819 3922Sales Growth 2.7% 2.7% 2.7% 2.7%Net Income 598 614 630 647 664PharmaciaSales($MM) 3844 4040 4246 4462 4690Sales Growth 5.1% 5.1% 5.1% 5.1%Net Income 402 422 443 466 490CombinedSales($MM) 7518 8044 8607 9209 9854Sales Growth 7.0% 7.0% 7.0% 7.0%Net Income 1092 1328 1533 1641 1756
Equity ValuationEquity Valuation
Upjohn Inc.Based on Discounted Abnormal Earnings: $4,371$4,371MMBased on Share Price (08/18/95): $39.63 x 171 shares = $6,776MM
Pharmacia ABBased on Discounted Abnormal Earnings: $4,371$2,844MMBased on Share Price (08/18/95): $39.63 x 171 shares = $6,776MM
Combined EntitiesBased on Discounted Abnormal Earnings: $4,371$10,256MMBased on Share Price (08/18/95): $39.63 x 171 shares = $6,776MM$13,247MM
PHARMACIA & UPJOHN INC.PHARMACIA & UPJOHN INC.Post MergerPost Merger
Merger was approved November 1995Merger was approved November 1995John Zabriskie became CEO of the John Zabriskie became CEO of the combined companycombined companyHead office was moved to EnglandHead office was moved to England3 regional head offices: U.S., Sweden & 3 regional head offices: U.S., Sweden & ItalyItaly
PHARMACIA & UPJOHN INC.PHARMACIA & UPJOHN INC.Post MergerPost Merger
Management announced in October 1996 Management announced in October 1996 lower than expected 3lower than expected 3rdrd quarter earnings quarter earnings due to merger integration issuesdue to merger integration issuesStock price dropped by about 10%Stock price dropped by about 10%Loss of about $2.8 billion in market cap. Loss of about $2.8 billion in market cap.
PHARMACIA & UPJOHN INC.PHARMACIA & UPJOHN INC.Post MergerPost Merger
Company continued to report earnings Company continued to report earnings below expectations for 4 quarters in a rowbelow expectations for 4 quarters in a rowPoor performance was attributed to Poor performance was attributed to implementation problems due to cultural implementation problems due to cultural differences between Upjohn & Pharmaciadifferences between Upjohn & PharmaciaJohn Zabriskie resigned as CEO early John Zabriskie resigned as CEO early 19971997
PHARMACIA & UPJOHN INC. PHARMACIA & UPJOHN INC. 19981998
Hired a new CEO – Fred Hassan, ex-executive Hired a new CEO – Fred Hassan, ex-executive from American Home Productsfrom American Home ProductsMoved head office back to the U.S.Moved head office back to the U.S.Established a centralized management teamEstablished a centralized management teamAggressively cut costs, shutting down 2 research Aggressively cut costs, shutting down 2 research sites, dismantled 3 independent centressites, dismantled 3 independent centresStrengthened new-product pipeline by killing Strengthened new-product pipeline by killing several research projects with poor prospects several research projects with poor prospects Analysts are warming up to the stock, upgraded Analysts are warming up to the stock, upgraded from a “Neutral” to “Attractive’ BUY rating in June from a “Neutral” to “Attractive’ BUY rating in June 19991999
PHARMACIA & UPJOHN INC. PHARMACIA & UPJOHN INC. 2003 2003
““For over 150 years people have counted on For over 150 years people have counted on Pfizer to discover and develop important new Pfizer to discover and develop important new medicines. The acquisition of Pharmacia/Upjohn medicines. The acquisition of Pharmacia/Upjohn will allow us to do even more. We want to be the will allow us to do even more. We want to be the most valued company to patients, colleagues, most valued company to patients, colleagues, shareholders and the communities where we shareholders and the communities where we work and live.”work and live.”Hank McKinnell, Pfizer Chairman and CEOHank McKinnell, Pfizer Chairman and CEOApril 16, 2003 April 16, 2003