In mid-March, Merck (MRK) and Sanofi-Aventis (SNY) announced they would be combining their animal health units in a deal, which pending regulatory approval, would create the largest supplier of veterinary medicines in the world. The pairing would represent nearly 30% of the $19 billion a year global market, surpassing Pfizer’s (PFE) animal health business, which currently accounts for about 20% of the market.
The deal actually revisits a previous pairing between the two in which both teamed up to create Sanofi’s current animal health business, Merial. However, Merck sold its 50% stake to Sanofi last year for $4 billion to help fund its $41 billion acquisition of Schering-Plough, which already had a prominent animal health unit of its own called Intervet. Due to the higher value of Intervet, Sanofi will pay Merck $250 million to re-establish the joint venture on top of the $750 million agreed upon last year when Merck sold its stake in Merial.
Indeed, both Intervet and Merial will complement each other well in the animal health sector, as there does not appear to be much overlap between the two businesses. First, Merial operates mainly in North and South America, Intervet operates in Europe and emerging markets. Second, Merial primarily specializes in house pets, since cats and dogs, providing products, such as flea and tick treatments, while Intervet focuses more on livestock, producing cattle vaccinations. Merial’s top-selling product, Frontline, accounted for about 65% of total sales in 2009, while Intervet’s respiratory vaccine for cattle, Bovipast, accounted for about 75% of it’s 2009 revenues.
Looking forward, the animal health market appears to be quite attractive as it is estimated to grow at roughly 5% annually over the next five years, driven partially by rising demand for livestock in emerging markets. As wealth grows within these emerging economies, consumers are able to incorporate more protein-rich foods into their diets that they possibly couldn’t afford previously. A diet high in protein typically calls for eating more meat (i.e. chicken, pork, beef). Hence, there is rising demand for livestock and livestock medicine.
In addition to livestock needs, an increase in wealth also tends to lead to people taking better care of their house pets. Pet owners, who have neglected to protect their cats and dogs from various infections or ailments (i.e. fleas and ticks), may be more inclined to do so with a little extra disposable income. All in all, an expanding middle income sector could help bolster more sustained growth moving forward.
In our view, the transaction appears to fill a similar need for both parties. Sanofi and Merck alike have been searching for ways to diversify their businesses in recent years to prepare for upcoming patent losses. Sanofi is scheduled to lose exclusivity on several profitable drugs in the coming years, which ought to leave a considerable dent in its top line. Merck, on the other hand, has already begun to experience the pitfall. Its popular hypertension medication, Cozaar/Hyzaar, fell victim to generic competition in April. The drug generated nearly $3.5 billion in revenues in 2009, accounting for about 13% of Merck’s total revenues for the year. Merck is also set to lose its patent on Temodar, one of its highest margined products, in late 2010, though the company’s recent acquisition of Schering-Plough is expected to lighten the patent expiration blow a bit.
All told, we view this pairing favorably. Besides filling an upcoming profit void in the human medicine divisions, we believe both companies will benefit from a more diverse product pipeline and increased market exposure. If all goes according to plan, the deal could be finalized later on this year, or possibly early 2011.