Puzzling Merck and Millipore Deal

Over the weekend, Merck KGaA of Germany (not to be confused with the bigger Merck Inc.) put in a $7.2 billion bid for Millipore, a maker of life sciences research products, beating out an earlier offer of $6 billion by Thermo Fisher Scientific.  I’ve done some consulting work in the life sciences sector, but I don’t follow it closely.  Even so, this transaction puzzles me, so I decided to spend some time thinking about it further.

The bid is at a 50% premium to where Millipore was trading before acquisition speculation started, which is pretty hefty.  And Merck claimed that they expect about $100 million of cost savings annually within three years.  The net present value of those cost savings depends on discount rates and whatnot, but I would guess it’s not more than $1 billion (not to mention that firms are often overly optimistic about merger cost savings).  That leaves a premium of $2.5 billion or so.  For the deal to create value for Merck shareholders, it would need to be justified by improvements that are worth at least that much.  Other than cost savings, companies usually look for revenue synergies (i.e., we can sell more of the two combined product lines to the same customers than we could individually, due to cross selling), or improvement opportunities (i.e., the acquired company is running its business poorly, and we can simply fix it up by improving marketing, manufacturing, etc.).

So let’s take a closer look at the two companies and see whether there’s potential for these kinds of improvements.  Millipore put in pretty anemic growth the last two years, growing 5% in 2008 and only 3% in 2009.  After 22% growth in 2007, that does look like quite a problem.  Maybe there’s something going on that Merck could fix?  I’m skeptical.  First, the low growth is probably driven by an overall downturn in R&D spending in pharmaceuticals.  Due to the economic downturn, many of the big firms have cut back on spending, especially in the preclinical research where Millipore’s products are the most relevant.  Since clinical trials are for products that are closer to getting to market, those get priority when spending is cut.  Second, Merck’s growth is even worse, at 2% for 2009, and they cite the downturn as being the main driver there.  In fact, Merck’s chemicals division is truly in pain, with a 9.5% decline for the year.  The pharmaceuticals business, in contrast grew 7%.  If there is a management solution to the grim market outlook in life sciences supplies and chemicals, it’s not apparent that Merck has it.  We can probably conclude that revenue growth is unlikely to justify the remaining $2.5 billion premium after cost savings.

The acquisition would almost double the size of Merck’s non-pharmaceuticals business.  Although people like to run big businesses for reasons of pride, it’s often difficult to explain to shareholders that way.  That’s when you hear statements like this one: “The acquisition is fully in line with Merck’s strategy of focusing on high-margin, specialty products with an attractive growth profile. In addition, the transaction will lead to a more balanced business profile for the Group. Currently, the Chemicals business sector generates around 25% of Merck’s total revenues.  Following the transaction, the chemicals business will contribute 35% of total Group revenues.”  Hmm, an attractive growth profile after growing 3-5% the last two years?  To be fair, Merck’s chemicals business does have an operating margin of almost 17% compared to 7% in pharmaceuticals, so I can understand their desire to grow the business.  But overpaying for it isn’t the right way to do it.

The conventional wisdom is that most mergers and acquisitions destroy value for shareholders.  That’s not always true.  Serial acquirers, who typically make small and easy to digest acquisitions, often do well.  Larger firms also sometimes perform well when they can make a bigger acquisition as a “platform for growth” and then bolt on smaller companies to fill out the product line, but that requires excellent integration skills.  In this case, there’s no evidence that Merck has a strong strategy along those lines, or the skills to pull it off if they do.  It’s possible that they do, but if so, they should start shouting it from the rooftops sooner rather than later.  Otherwise, the double-digit dip in Merck’s shares that followed the bid announcement is a good indicator of what investors are going to think of the planned acquisition.

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