Upjohn – Pharmacia Merger

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					Upjohn – Pharmacia Merger
  •Darryl Kraemer and Derek Webb
Agenda

•   Industry Strategic Issues
•   Industry Response
•   Background
•   Assessment of Merger
    – Class Exercise
• Prospective Analysis
• Post Script
Industry Strategic Issues
Industry Strategic Issues

• Cost concerns putting pressure on drug
  companies to lower prices
• Industry consolidation to lower costs
  from economies of scale
• Highly fragmented with many competitors
• In the 1980’s, drug companies had high
  power
Industry Strategic Issues

• In the 1980’s, buyers consolidating into
  larger entities b/c of cost pressure
• Drug purchase decisions made by HMO’s
  and plan admins
• Bulk purchases = lower prices
• Formularies are docs short list of
  approved drugs
• Buyers want limited number of suppliers
  with variety of products
Industry Strategic Issues

• Few new blockbuster drugs are in the
  pipeline
• Generic drugs used when possible for
  reduced costs
• Docs have financial incentive to prescribe
  generics
• Generics price ½ of brand equivalents
• Generic comprised 23% of market in
  1980, 40% in 1990 and 66% by end
  1990
Industry Response
Industry Response

• Operations changed to become more
  efficient
• Operations downsized, restructured, loss
  of jobs
• Non-core businesses divested
• JV’s with medical device companies and
  care providers for total package
• Industry wide consolidation
 Industry Response

• Vertical consolidation to move closer to
  patients, acquire PBM, HMO
• Horizontal consolidation because:
  –   Buyer strength increasing
  –   Cost to develop new drugs increasing
  –   Markets expanding worldwide
  –   Looking for larger markets to spread costs
  –   Seeking efficiency gains to reduce R&D costs
• More horizontal than vertical integration,
  though vertical seen as way of the future
Industry Response

• Industry future looks strong because:
  – Aging population, with increased prescription
    coverage in insurance plans
  – Pharmaceutical products more cost effective
    than hospitalization
  – Number of countries attempting to improve
    health care systems
  – Industry is relatively recession proof
Background
Background

• Upjohn
  – 19th largest pharmaceutical company – midsized
  – 7 product categories:
     •   Central nervous system
     •   Steroids
     •   Anti-inflammatory and analgesic
     •   Reproductive and women’s health
     •   Critical care, transplant and cancer
     •   Infectious disease
     •   Metabolic
Background

• Upjohn cont’d
  – 10 products comprise 56% of sales
  – International sales small portion of revenue
  – Numerous patents have expired causing:
    • Lower prices
    • Lots of competition from generic brands
    • Reduced margins
  – Few blockbuster drugs in the pipe
  – Weak in foreign sales
Background

• Pharmacia
  – 18th largest pharmaceutical company – midsized
  – 7 product categories:
     •   Cancer treatment
     •   Growth hormones
     •   Cataract surgery products
     •   Intravenous nutrition
     •   Allergy diagnostics
     •   Smoking cessation
     •   Chemicals for Biotech R&D
Background

• Pharmacia cont’d:
  – 10 product comprise 44% of company sales
  – 59% of revenue in Europe, 16% in NA and
    Japan
  – Few blockbuster drugs in the pipeline
  – Larger number of products with small
    potential sales
  – Focused on niche segment of hospitals and
    specialists
  – Several acquisitions in the past
Assessment of Merger
Proposed Merger Details

• Tax free exchange of shares (pooling of
  interests)
• 1 Upjohn share = 1.45 shares in new company
• 1 Pharmacia share = 1 share in new company
• Upjohn’s Zabriskie would be President/CEO
• Pharmacia Ekberg would be non-executive
  chairman
• Corporate headquarters in London
• Operational headquarters in Stockholm,
  Kalamazoo and Milan
Class Exercise

•   Class will be split into 4 groups:
     1.   Upjohn shareholders
     2.   Pharmacia shareholders
     3.   Management of Upjohn
     4.   Management of Pharmacia
•   See handouts for questions
•   15mins to prepare overhead
•   5mins for presentation of answers
Prospective Analysis
Prospective Analysis

• Assumptions:
  – Key drivers of operation is sales
  – Management believes combined companies will grow
    faster than separate, and faster than industry
     • 7% growth rate for next 4 years for combined firm
     • 2.7% for Upjohn separate
     • 5.1% for Pharmacia separate
  – Operating costs synergies of $500M, with 85% in
    place by 1996
  – Results in operating margin > 25% by 1998
Prospective Analysis

• Assumptions cont’d:
  – Capital structure:
     • 50/50 debt/equity for combined firm
     • 52/48 for Upjohn separate
     • 42/58 for Pharmacia separate
  – Interest costs based on all debt = 2%
  – WACC assumed to be 8%
Prospective Analysis

• Assumptions cont’d:
  – Net operating working capital as % of sales:
    • 69% for combined firm
    • 62% for Upjohn separate
    • 76% for Pharmacia
  – Long term assets as % of sales:
    • 88% for combined firm
    • 90% for Upjohn
    • 86% for Pharmacia
        Prospective Analysis
  •Upjohn operating separately
In millions       1996            1997            1998          1999           2000


Sales              3527           3622            3719           3819           3922


Net                598             614             630            647           664
Income

Total              5243           5361            5506           5653           5805
Assets

Abnormal           245             251             257            264           271
Earnings
Value of equity based on discounted abnormal   Value of equity based on share price:
earnings: $4,371,000,0000                      $39.63 X 171,000,000 = $6,776,000,000
        Prospective Analysis
  •Pharmacia operating separately
In millions       1996            1997            1998          1999           2000


Sales              3844           4040            4246           4462           4690


Net                402             422             443            466           490
Income

Total              5963           6227            6544           6879           7228
Assets

Abnormal           (76)           (77)             (82)          (85)           (89)
Earnings
Value of equity based on discounted abnormal   Value of equity based on share price:
earnings: $2,844,000,0000                      $25.38 X 255,000,000 = $6,471,000,000
        Prospective Analysis
  •Combined firm
In millions      1996E           1997E           1998E           1999E           2000E


Sales              7518           8044            8607             9209            9854


Net                1092           1328            1533             1641            1756
Income

Total             11137          11803            12629           13513           14458
Assets

Abnormal           308             502             649             696                 744
Earnings
Value of equity based on discounted abnormal   Value of equity based on share price:
earnings: $10,256,000,0000                     $6,776,000,000+$6,471,000,000 =
                                               $13,247,000,000
    Prospective Analysis

   •DuPont Analysis
            Profitability    Asset     Leverage   ROE
                            Turnover

Upjohn         0.152         0.655      2.095     21%
(1995)

Pharmacia      0.106         0.614      1.723     11%
(1995)

Combined       0.178         0.682      1.410     17.1%
(2000E)
Post Script
Post Script

• Merger was approved as proposed in Nov
  1995
• In Oct 1996, management expected to
  report lower than expected 3rd quarter
  earnings due to integration problems
• Stock price dropped by 10% in response
  (~$2.8billion, reversing merger gain)
• Continued to report earnings below
  expectations
Post Script

• Zabriskie resigned in 1997
• Appointed Hassan as new CEO (American
  Home Products, Harvard MBA)
• Solution:
  – Moved head office back to USA
  – Centralized management team, all recruited
    from the outside
Post Script

• Solution cont’d:
  – Cost cutting:
     • Shutting two research sites in Sweden
     • Dismantled operations centers in Stockholm,
       Milan and Kalamazoo
     • Overhauled purchasing practices
  – Accelerated launch of new product – Detrol
  – Licensed external products
• Analysts warming to stock in June 1999
Post Script

• Bear Sterns upgraded stock from Neutral
  to Attractive
• Stock traded at P/B = 5 in June 1999,
  well below industry multiple of 21, and
  S&P multiple of 8.5

				
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