Tuesday, March 10, 2009

Merck/Schering-Plough Merger Arbitrage Opportunity

In this tough market, investors are always looking for a way to make a buck. Merger Arbitrage is a strategy where investors could profit from the spread between the current price of the target and the expected price at close of the deal. This could be one strategy where investors could shore their funds during the current market turmoil and still make a buck.

Warren Buffett had a nice discussion on his arbitrage experience with Arcata Corp in the 1980’s in his 1988 letter to Berkshire Hathaway shareholders.

"To evaluate arbitrage situations you must answer four questions:

(1) How likely is it that the promised event will indeed occur?

(2) How long will your money be tied up?

(3) What chance is there that something still better will transpire - a competing takeover bid, for example?

(4) What will happen if the event does not take place because of anti-trust action, financing glitches, etc.?"

The big news yesterday was Merck’s multi billion-dollar deal to acquire Schering-Plough. For each share of Schering, shareholders will receive 0.5767 shares in the new company plus $10.50 in cash. Merck will use $9.8 billion of its own cash for the purchase plus $8.5 billion in short-term financing. The companies expect the deal to close in the fourth quarter of this year, subject to regulatory approval.

The merger is subject to shareholder approval from both companies. The FTC would have to review the deal for overlap in drugs and other products in development or currently sold by Merck and Schering-Plough. The FTC could also force the companies to sell some products before a green light for the merger is given.

Another stumbling block might be the arthritis drugs Remicade and golimumab, for which Schering-Plough acquired the rights to sell it internationally from Johnson and Johnson. Under "change of control" clauses in the companies' partnership agreements, J&J has the opportunity to acquire the full rights to the drugs if Schering-Plough gets taken over. That's why the deal is structured as a reverse merger, where Schering-Plough will be the surviving company under the Merck name.

Investors who believe that the merger will go through could profit by purchasing Schering-Plough shares and selling short 57.67 MRK shares for every 100 SGP shares bought. At the current prices for Merck (MRK) and Schering (SGP), which yesterday closed at 20.99 and 20.13 respectively, investors could earn a 12.30% return by the end of the year through this arbitrage opportunity.

Another pharma arbitrage play to watch is Pfizer/Wyeth Merger Arbitrage Opportunity. Pfizer (PFE) will pay $33 in cash plus 0.985 shares of Pfizer stocks for each share of Wyeth (WYE). On Monday Wyeth closed at $40.76, which is 10.30% lower than the combination of Pfizer stock and cash, at the current price for Pfizer at $12.63.

In a document filed with the SEC several reasons why the Pfizer/Wyeth Merger Arbitrage Opportunity might not go through were listed:

“ There is the possibility that the merger does not close, including, but not limited to, due to the failure to satisfy the closing conditions; Pfizer's and Wyeth's ability to accurately predict future market conditions; dependence on the effectiveness of Pfizer's and Wyeth's patents and other protections for innovative products; the risk of new and changing regulation and health policies in the U.S. and internationally and the exposure to litigation and/or regulatory actions. the ability to obtain governmental and self-regulatory organization approvals of the merger on the proposed terms and schedule; the failure of Wyeth stockholders to approve the merger”

It would also be interesting to see if Merck (MRK) will continue paying its current rich dividend to shareholders and won’t cut it, which was what Pfizer (PFE) did when its merger with Wyeth (WYE) was announced.

Full Disclosure: None

Relevant Articles:

- Pfizer/Wyeth Merger Arbitrage Opportunity

- Is Pfizer (PFE) a value trap for investors?

- Dow Chemical (DOW) To Acquire Rohm and Haas (ROH)

- Anheuser-Busch (BUD) Deal Finalized

Popular Posts