Monsanto's proposed merger of equals with Pharmacia & Upjohn hinges upon convincing shareholders that there is value in delaying the unlocking of Monsanto's ag business from the Searle pharmaceutical business.

The initial reaction to the proposed merger has been tepid, with shares of both Monsanto and P&U trading down following the Dec. 19 announcement of the merger. The decline in Monsanto shares has shaved about $4 bil. (15%) off of the original $27 bil. valuation of the deal.

Monsanto has been under pressure from shareholders to separate its drug and ag businesses in the belief that Searle would command a premium price based on the performance of the COX-2 inhibitor Celebrex.

The ag business is facing international political pressure related to genetic modifications of crops.

In addition to persuading Monsanto shareholders to accept a no-premium merger in the short-term, the two companies will have to persuade P&U shareholders to accept the ag business as part of the acquisition of Searle.

The merger agreement calls for a 20% spin-off of the ag division via an initial public offering within a year. However, because the deal is a pooling of interests transaction, the merged company is unlikely to be able to divest the ag business completely for at least two years without adverse tax consequences.

From Monsanto's point of view, one reason for keeping the Searle and ag divisions together may be to preserve the opportunity to complete a pooling merger. A major capital restructuring precludes use of pooling accounting for two years, and changes to accounting standards will foreclose the pooling option altogether in 2001.

Monsanto may also be reluctant to spin off the ag business at a time when it views the value of the business as unreasonably depressed.

P&U CEO Fred Hassan, who will become CEO of the merged company, declared his belief in the long-term value of the ag business. "The reason we want to do this IPO is because we believe that one can unlock a lot of value in this ag business by making it stand alone, by making it totally accountable to its own shareholders, and by making it transparent."

Hassan maintained that the public relations problem in Europe can be resolved if "managed in a very cool and professional manner."

While stressing the currently unappreciated value in the ag business, Hassan did not define a synergy value between drugs and ag. The ag business, he declared, will operate "as an autonomous business, because we are doing this merger to make us a global pharmaceutical powerhouse." The agriculture business will have its own management and board of directors.

When Monsanto acquired Searle in 1985, it initially wanted to acquire the prescription drug business independent of Searle's NutraSweet artificial sweetener and OTC business.

Ironically, NutraSweet was the hidden value in the deal, providing one of the main payoffs to Monsanto from its $2.7 bil. investment in Searle before the Celebrex success.

The P&U agreement may be Monsanto's last opportunity to complete an agreement that involves both the ag and Searle divisions.

Monsanto negotiated a friendly merger with American Home Products in 1998, but the deal fell through in part because of a lack of enthusiasm among investors for the "life sciences" synergy model espoused by the agreement.

More recently, Monsanto had discussions with Novartis about a possible merger. Novartis, however, opted to abandon the life sciences field and combine its ag business with AstraZeneca's ("The Pink Sheet" Dec. 6, 1999, p. 16).

A number of companies, including Lilly, are said to have talked to Monsanto about acquiring the Searle business. If the P&U agreement falls through, Monsanto may be forced to spin-off the drug business.

Monsanto CEO Robert Shapiro acknowledged that a spin-off of Searle "was attractive." However, he maintained, "in our view as we have studied P&U's business plan and its pipeline, we believe there is substantial upside value that our shareholders now aregoing to participate in that wouldn't have been possible in other configurations."

There are clear indications that the P&U agreement was arrived at hastily. On a symbolic level, the combined company does not yet have a name.

In addition, the companies were forced to issue a press release following the Dec. 20 briefing clarifying some of the projections made about the combined company after some investors expressed confusion.

If the companies are successful in selling the merger to shareholders, the next challenge will be avoiding the integration difficulties that occurred in the Pharmacia & Upjohn merger.

Hassan was brought in to P&U to offer an outside eye to the integration process and has been credited with righting the company.

Merger "execution is 80% of success," Hassan declared, "and how a merger is executed is the basis for the real value that gets generated." He touted his experience as a reason to anticipate success from the merger: "I personally have had experience with four different mergers."

The companies project synergies of $600 mil. per year from the combination. The corporate headquarters will be based in Peapack, N.J., where P&U is based. Searle's Skokie, Ill. headquarters would remain as an R&D site, and Monsanto's St. Louis headquarters would remain the headquarters of the ag business.

While Hassan would be CEO of the company (and would take over from Shapiro as chairman after 18 months), Searle's Philip Needleman, PhD, would be the top research exec (see following story).

One immediate benefit of the agreement would be increased sales support for the key products of the two companies, including Searle's Celebrex and P&U's Xalatan and Detrol.

The sales force of the merged entity would rank seventh in the U.S., with 3,800 reps, and fourth in "key western European markets," with 2,500 reps, the companies said.

The merged company intends to retain its co-promotion agreement with Pfizer for Celebrex (see related story, p. 6).

Estimated 1999 sales for the overactive bladder therapy Detrol are expected to be $300 mil., representing a 200% increase over last year, Hassan said. The glaucoma treatment Xalatan is expected to generate $500 mil. this year, 50% more than in 1998, he added.

P&U's antibiotic Zyvox (linezolid), which has been fast-tracked at FDA with a user-fee goal of April 2000, is also expected to contribute to the combined company's growth.

P&U's antidepressant Vestra (reboxetine), Aromasin (exemestane) for cancer and pegvisomant for acromegaly are anticipated 1999-2000 product launches for the merged entity.

The Monsanto merger would free P&U from the need to find a primary care partner to market Vestra.

Vestra was not included among a list of key products for the merged company presented during the Dec. 20 teleconference. Hassan explained that Vestra is not expected to immediately drive growth of the new company because it will be rolled out initially to psychiatrists via a co-promotion agreement with Janssen.

Searle has three Phase III products in line for launch during 2001-2002, including two COX-2 inhibitor follow-ons to Celebrex.

Searle's eplerenone for congestive heart failure and hypertension is also tagged as a potential growth product slated for launch in 2001-2002. Eplerenone is in Phase III.

The combined company would have a relatively young product platform. The first significant patent expiration would be for Camptosar, which will lose exclusivity in 2007.

P&U and Monsanto expect to generate "total peak sales" of $8 bil. to $10 bil. by 2002. The P&U/Monsanto combination would have an R&D budget of $2 bil.

Between 1999-2002, the combined pharmaceutical business is expected to grow at a rate of 14%-15%. Combined debt of the two companies is estimated at $6.8 bil. for 1999. A debt reduction to $4.5 bil. is expected by the end of 2000, based on proceeds from the divestiture of Monsanto's nutrition and consumer businesses, but not the agriculture IPO.

Monsanto/P&U Aggregation Hinges On Ag Business: Pull Of Pooling?

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