Mergers and Aquisitions

Merger & Acquisitions

MERGER AND ACQUISTION

Merger and Acquisition

Merck & Company Inc. is an American pharmaceutical company operating in different countries globally. The company is one of the world largest manufacturers of drugs by revenue and market capitalization, and the company offers different products such as vaccines, prescription products, consumer products and animal products. Its operative business is being operated by MerckKGaA where 30% of the shares are publicly traded and the Merck's family owns 70% of the company interests. Merck operates four different business divisions such as Consumer Health (over-counter pharmaceuticals), Merck Serono (biopharmaceuticals), Merck Millipore (pharmaceutical research & technology products) and Performances Materials (high-tech chemicals). (Merck, 2011). Typically, the company Consumer Health division offers quality products globally and its brands are available in countries in the North and South America, Europe, African and Asia. Over the years, the company has long known to improve people's health and well-being and the company is committed to improve the general well-being of people through its services. (Merck, 2011).

Medco

Medco Health Solutions, Inc. is one of the largest American Pharmacy Benefits Management companies that served over 65 million people. Moreover, the company is an American PBM (Pharmacy Benefits Management) that offers services to 65 million people. In 1992, Medico became a mass drug distributor with revenue of $2.5 billion and $138 million profits, and Medico Pharmacy operates 10 mail pharmacies with automated pharmacies in Las Vegas in the United States. Typically, Medico currently holds 42 U.S. patents for data management, automated, pharmacy technology, as well as 56 international patents in automated pharmacy-dispensing technology.

In 1993, Merck & Co announced to acquire Medco Containment Services Incorporation at $6.6 billion. The Medco was the largest (PBM) prescription benefits management company, and "the major marketer of mail-order medicines in the United States." The merger between the two companies reflected a fundamental changes in the pharmaceutical industry in the United States and globally. (Carol, 2002).

However, there are debates concerning the benefits and shortcomings that the Merck Company will derive from the merger. Supporter of the merger maintained that the two companies would derive the competitive market advantages from the merger process. Merck management identified that Medico extensive database was the key driver for initiating merger process because the Medico maintained the computer profile of more than 33 million customers that amount to 26% of all people who are covered by a pharmaceutical benefit plan. Thus, the database will assist Merck to enjoy numerous sales, and the company will be able to record an annual costs saving of more than $1 billion in redundant marketing. Acquisition of Medico will assist the Merck to increase the market shares and decrease the prices of its products by capitalizing on its valuable capital assets. The company will be able to decline the cost of capital through the merger thereby increasing the overall profitability.

Despite the benefits to be derived from the merger, a criticism put forward was that the two companies operated under the different cultural background, which would make the merger process to be unsuccessful.

Objective of this paper is to evaluate whether Merck should proceed with the merger or not. The paper uses the discounted cash flow (DCF) to evaluate whether Merck should proceed with the merger. The DCF assists in identifying the least chance of the earning the costs of capital as well as the earning benefits to be derived from the merger. Thus, the discounted cash flow assists in revealing the ability of the company to meet its objectives. The paper uses the historical financial records for the discounted cash flow.

Pre-Merger Process

The paper discusses the Merck & Co and Medco historical financial records for the pre-merger process. The financial records of the two companies are used to evaluate the company financial capabilities for the merger process using the historical records from 1988 and 1992. In 1988, Merck recorded $5.93 Billion in sales. In 1989, the company annual sales increased to $6.55 billion. In 1990, the company annual sales increased to 7.67 billion. By 1992, the company was able to increase its annual sales to $9.66 billion. The increase in the company yearly sales revealed that Merck was recording increase in customer's patronages. Similarly, the company was maintaining the net income gain from 1988 and 1992. The company net income was $1.2 billion in 1988 and increased to 1.49 billion in 1989. By the end of the 1992 fiscal year, the company net income gain increase to $2.1 billion. Merck was also recording an increase in the overall total assets between 1988 and 1992. The company total assets were $6.12 billion in 1988 and increased to $6.75 billion in 1989. At the end of the 1992 fiscal year, the company total assets had increased to $11.09 billion. The value of the company shareholder's equity also increased from $2.95 billion in 1988 to $5.0 billion in 1992.

Medco Historical Financial Records

This paper also uses the Medco historical financial data from 1989 to 1992 to evaluate the merger of both Merck and Medco. The Medco recorded the net sales of $737.9 million at the end of the fiscal year 1989. However, the company net sales increased to $1.02 billion in 1990. By the end of the 1992 fiscal year, the company had recorded $1.89 billion in the net sales. Similar to Merck that recorded net income gain from 1998 to 2002, Medico was also able to record net income gain from 1998 to 1992 except in 1990 that the company recorded a net income loss of $6.7 million. In 1998, the company recorded the net income gain of $29.2 million. By the end of the 1992 fiscal year, the company had increased its net income gain to $1.05 billion. Similarly, the company total assets increased from $507.1 million in 1989 to $1.25 billion in 1992. The company shareholder equities also increase from $291.2 million in 1989 to $690 million in 1992.

Post-Merger Analysis of Merck and Medco Financial Records

Analysis of post merger of the two companies is very critical to enhance greater understanding on whether to accept the merger process or not. The paper uses discounted cash flow for the analysis. Combined financial records of the two companies reveal that the two companies recorded $11.66 billion in the annual sales when combining their financial records together in 1992. However, the sales recorded by the two companies for the six months ended on June 30, 1993 were $6.2 billion. Moreover, the two companies recorded the combined net income of $2.3 billion for the fiscal year 1992 and $756 million net income within six months in 1993.

Moreover, the combined total assets of the two companies valued 19.7 billion by June 30, 1993, while the long-term debts valued $1.58 billion, and the overall value of the shareholders' equity of the two companies were $1.18 billion. More importantly, the book value per common share for Merck was $6.12, while the book value per common share for Medco valued $4.33.

Discounted Cash flow for the Analysis

While there are several techniques to conduct the analysis of the company value, the discounted cash flow is widely regarded as the best method to conduct the merger analysis. The DCF is the most accurate method of determining the worth of the company and it is widely being used by professional as well as individual investors. The assumption of DCF projection is by estimating what the company will earn in the future and translates it to the present dollar amount. Essentially, the aim of merger is to increase the value of both Merck and Medco because it will increase the shareholder's values. Essentially both companies stand to gain the synergistic benefits that come out from the two company's cash flow, which is referred as "[PVAB = PVA + PVB + gain]":

Where PV= the discounted cash flow of the merged firms. The assumption of this equation is that [6 = 2 + 3 + gain], and the gain is translated into tax advantages, economies of scale, market advantages, risk diversification and opportunity to enter the new industry.

Thus, the main idea of merger is to increase economic of scale by enhancing cost reduction which ultimately leads to increase in profit. (Arnold, 2002). Following this assumption, the paper starts the DCF from free cash flow.

The first step to determine the DCF is to estimate the free cash flow (FCF) of the two companies to evaluate the post-merger process. The paper starts with the revenue growth of the two companies.

Table 1: Merck Free Cash Flow

Historical Financial Record ($Million)

Projection Financial Record

1988

1989

1990

1991

1992

1994

1995

1996

1997

1998

1999

Sales

10,822

12,121

13,575

14,933

16,426

18,068

Growth Rate

10.29%

17.11%

12.14%

12.32%

12%

12%

12%

10%

10%

10%

Net Profit

3

4

4

4

5

Growth Rate

25%

20%

16.67%

19.05%

20%

20%

20%

20%

20%

Table 2: Medco Free Cash Flow

Historical Financial Record ($Million)

Projection Financial Record

1988

1989

1990

1991

1992

1994

1995

1996

1997

1998

2018

Sales

3,542

4,782

6,456

8,716

11,330

14,729

Growth Rate

38.93%

35.52%

36.24%

38.63%

35%

35%

35%

35%

30%

30%

Net Profit

45.2

12.9

98.7

Growth Rate

-71.46%

74.16%

34.96%

30%

30%

30%

30%

30%

The table 1 reveals that the growth that Merck Company achieved within five years between 1998 and 1992. Using the CAGR (compound annual growth rate) of 12.32% within the past 5 years, it is revealed that the 12.32% is good starting point for forecasting. The paper uses the average growth for forecasting (10.29%+17.11%+12.14%+12.32%) =12.9%. Since most companies may not be able to sustain the average growth rate for some time. The paper uses the 12% as the forecasting point for revenue for the Merck & Co. Based on the results of the forecasting, it is revealed that the company would be able to maintain 12% growth rate in sales at post-merger. Moreover, the company will be able to maintain 20% growth rate for the net income.

Moreover, the table 2 reveals the Medco free cash flow that shows that the company would be able to maintain growth rate of average of 35% within 5 years after 1993. Using the revenue growth analysis, it is revealed that both companies will maintain a healthy growth in revenue within five years after the merger. Moreover, Medco would be able to maintain the health growth rate of 30% for the net income five years at post-merger.

The price $6.6 billion that Merck paid for the merger was good because the company book value per share will increase from $7.30 instead of $4.33 before the merger. Typically, Merck book value per common share was $4.33 while Medco book value per common share was $6.12. Merger would assist Merck to boost its book value to $7.30.

Based on the results of the projected cash flow, this report provides the recommendations whether both companies should proceed with the merger process or not.

Recommendations

This report advises that both Merck and Medco should proceed with the merger process based on the results of the analysis delivered in Table 1 and 2. The external evaluation of the Medco financial performances after the merger reveals that the company would record a healthy financial record at post-merger. The data in the table 3 reveal that Medco will record the $3.5 billion in sales in 1994, $4.7 billion sales in 1995 and 6.4 billion sales in 1996. Moreover, Medco will record an increase in the net income from $199 million in 1994 to $389 million in 1996. Moreover, the company will record the increase in the cash flow from financial and operating activities from $182.9 million in 1994 to $270.5 million in 1996. Based on the data delivered, it is revealed that the Merck will enjoy several financial and non-financial benefits by initiating merger with Medco. (Main, Wiss, Motoba, et al. 2012).

Table 3: Projection for Medco ($Million) Except share amount

1994

1995

1996

Sales

3.542.0

4.779.9

6.439.0

Net Operating Profit

Net Income

Earning Per Shares

1.21

1.68

2.32

Change in Working Capital

(66.4)

(129.0)

(207.5)

Capital Expenditure

(45.0)

(40)

(40)

Cash Flow from Operating & Financing Activities

Source: Thomson Reuters. (1993).

Merck will enjoy the following benefits by initiating merger process with the Medco:

One of the benefits of the merger is that Merck will be able to increase its annual sales making the company to dominate the pharmaceutical industry. The unaudited pro-formal financial record reveals that the Merck will record annual sales of $6.3 Billion immediately after the merger. With the increase in the sales growth rate of both Merck and Medico, the Merck would able to record the 47% growth rate in sales after the merger instead of the 12% growth if there was no merger process. Moreover, the company will enjoy increase in the overall net income after the merger. Typically, the Merck would be able to record 50% growth rate in the net income after the merger. However, if Merck did not initiate the merger, the company will only record 20% annual growth in the net income.