A spoonful of premium makes the medicine go down: Merck & the latest mega- merger in the healthcare sector Merck KGaA, Market Cap (as of 26/09/2014): €31.4bn Sigma-Aldrich Corp., Market Cap (as of 26/09/2014): $16.2bn On September 22, 2014, the German drug and chemicals company Merck KGaA announced a definitive agreement under which it will acquire the US-based leading life science consumables supplier Sigma-Aldrich for $17bn, creating one of the leading players in the $130bn global life science industry. Merck is a leading global pharmaceutical, chemical and life science company with approximately 38,000 employees across 66 countries and generating total revenue of €11.1bn in 2013. Merck's business divisions (Merck Serono, Consumer Health, Performance Materials and Merck Millipore) are controlled by Merck KGaA, in which Merck family holds about 70% interest while public shareholders own the remainder 30%. The announced deal is the biggest in the history of the company, surpassing the previous record set by the €10.3bn acquisition of the Swiss biotech company Serono. The leading life science and technology company Sigma-Aldrich manufactures and distributes more than 230,000 chemicals, biochemicals and other essential products to more than 1.4m customers globally, in research and applied labs as well as to industrial and commercial clients. The St. Louis-based company, of the largest makers of chemicals and biological materials used in scientific laboratories, operates in 37 countries with approximately 9,000 employees worldwide and generated total revenue of $2.7bn in 2013, half of which coming from academic labs, drug companies and industrial manufacturers. Thanks to this transaction, Merck has the chance to further diversify its business model by entering the life science sector, characterized by a stable growth pattern and high margins. In fact, the investments in pharmaceutical R&D have not yielded the hoped results: over the last 10 years the company has not been able to develop or discover any new drugs since its last major drug was approved in 2003. As a matter of fact, the pharmaceutical side of the business, which represents 55% company’s revenues (FY2013), is clearly turning out to be uncompetitive: the increased competition, the healthcare reforms and the government’s cost containment measures put further pressure on margins and on sustainable long-term growth perspectives, thus forcing companies in the pharmaceutical sector to move towards higher profit segments like rare disease treatments and high-tech products. According to Merck, the acquisition of Sigma-Aldrich is expected to significantly increase the scale of Merck’s operations and to generate substantial synergies mainly thanks to the optimization of R&D portfolio and to the consolidation of both the manufacturing footprint and the global distribution platform (in particular in US and in Asia). Indeed, €260m of synergies per annum are expected to be fully achieved in three years after the closing. The benefits will be partially offset by €400m of integration costs spread on the 2015-2018 period, thus leading to a 24% increase of the FY2013 pro-forma EBITDA (adjusted for one-off items) and a ca. 300 basis points increase of the EBITDA margin. Moreover, the credit profile of Merck is expected to improve thanks to the lower business risk arising from more stable cash flows and a higher degree of geographic diversification. Merck’s offer price stands at $140 per share, a 37% premium to the latest closing price of $102.37 on September 19, 2014. Accordingly, the total consideration is ca. $17bn, which implies an EV/EBITDA of 20.1x, fairly in line with the average of the US biotech sector. The transaction, expected to be immediately accretive in terms of EPS adjusted for one-off items, will be settled entirely in cash and debt. For this purpose, Merck has been granted bank loans and bridge financing as the take out financing structure will be formed by €4bn of bank loans, €7bn of bonds and €2bn of cash-in-hand (in total €13bn, ca. $17bn). Merck’s stock price reacted positively to the news, recording an increase by 4.14% upon announcement and reflecting a genuine support of investors. Similarly, Sigma-Aldrich share price rallied from $102.37 to $136.40 (+33.24%) upon announcement. The deal is expected to be closed in mid-2015, subject to regulatory approvals and other customary closing conditions as well as Sigma-Aldrich shareholders’ approval. Guggenheim Securities and J.P. Morgan are acting as financial advisers to Merck while Sigma- Aldrich is advised by Morgan Stanley. All the views expressed are opinions of Bocconi Students Investment Club members and can in no way be associated with Bocconi University. All the financial recommendations offered are for educational purposes only. Bocconi Students Investment Club declines any responsibility for eventual losses you may incur implementing all or part of the ideas contained in this website. The Bocconi Students Investment Club is not authorised to give investment advice. Information, opinions and estimates contained in this report reflect a judgment at its original date of publication by Bocconi Students Investment Club and are subject to change without notice. The price, value of and income from any of the securities or financial instruments mentioned in this report can fall as well as rise. Bocconi Students Investment Club does not receive compensation and has no business relationship with any mentioned company. Copyright © Sep-14 BSIC | Bocconi Students Investment Club Tags: accretive, healthcare, J.P. Morgan, JP Morgan, life science consumables supplier, M&A, Merck KGaA, Merck, merger, Morgan Stanley, Sigma-Aldrich, pharma, pharmaceutical .