Merck's acquisition of Medco Health Solutions

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).

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.

"Improved market reach and industry visibility - Companies buy companies to reach new markets and grow revenues and earnings. A merge may expand two companies' marketing and distribution, giving them new sales opportunities. A merger can also improve a company's standing in the investment community: bigger firms often have an easier time raising capital than smaller ones." (Investopedia, 2010).

Moreover, the Merck would be able to enjoy economic of scale by proceeding with the merger process thereby making the company to enjoy a decline in the cost of capital and offered low prices for the goods and services delivered to customers in the market. The decline in the cost of operations would assist the company to dominate the market thereby beat its domestic and international competitors. Additional benefits are that Merck would be able to enjoy supernormal profits because the company would able to enjoy $1 billion annual saving in redundant marketing. The company would be able to achieve a more precise marketing strategies brought about with the merger because the company will be able to use the Medco database to increase the market shares thereby increasing the company competitive market advantages.

More importantly, the Merger will provide the tax benefits for Merck because the acquired assets are written to the actual purchase price, which is different from the book value, and this reduces the tax payable annually.

Discussion

The report estimates whether the merger of Merck and Medco would be beneficial to Merck. The Merck & Co offered $6.6 billion to purchase Merck Company. Financial evaluation of pre-merger and post-merger reveals that Merck will achieve financial benefits from the merger. Thus, the paper suggests that Merck should proceed with merger based on the revenue and net income assumption. The report forecasted revenue and net income based on the historical life of the financial record of the two companies. The report forecasts that Merck will enjoy a 47% growth rate in revenue for the next years after the merger thereby making the company to dominate the market. Moreover, the Merck will achieve a net income growth rate of 50% after the merger.

Reference

Carol, U.K. (2002).Merck-Medco to become stand-alone PBM. Drug Topics.4:12.

Investopedia, (2010).The Basics of Mergers and Acquisitions. Investopedia Inc.

Main, A. Wiss, S. Motoba, A. et al. (2012). Merck & Co., Inc. (NYSE: MRK). Krause Fund Research.

Merck (2011). Merck Annual Report. Merck & Co.

Thomson Reuters .(1993).Merck Sharp & Dohme Corp. Westlaw Business.