What is the $17 billion Mega Acquisition in Germany?

Drugs and chemicals maker Merck KGaA agreed yesterday to acquire US-based Sigma-Aldrich Corp for $17bn in cash to boost its lab supplies business, the biggest takeover in the German group’s history.

The deal helps Merck, 70% controlled by the descendants of its 17th century founder, to focus more on supplying drugmakers and academic institutions with chemicals and services, seen as offering a steadier income stream than drug development.

“With this acquisition we have the opportunity to turn one of our most reliable businesses into a core earnings contributor,” said finance chief Marcus Kuhnert.

Merck, which has been hit by several drug development failures, said it was happy for its own pharmaceuticals business to remain a medium-sized entity.

The deal was approved by Sigma-Aldrich’s management but still needs acceptance from more than 50% of the target’s shareholders.

Merck said it will acquire Sigma-Aldrich shares for $140 apiece, a 36% premium over the one-month average closing price and a 37% more than the latest closing price of $102.37 on September 19.

St Louis, Missouri-based Sigma had 2013 sales of $2.7bn and provides big pharma groups including Pfizer Inc and Novartis AG with lab substances such as cell culture substrates. It also makes chemicals for the technology sector and food testing products.

The combined lab supplies business would gain more exposure in North America and Asia, taking on global players such as Thermo Fisher Scientific Inc The deal would immediately top-up adjusted earnings per share.

The move comes as healthcare companies strike deals at a record pace, with year-to-date activity in the sector topping $380bn, well over double the year-ago level, according to Thomson Reuters data.

It represents the second major transatlantic deal for a German company in the space of a few hours, after Siemens AG agreed to buy oilfield equipment maker Dresser-Rand Group Inc for $7.6bn.

Shares in Merck, which initially turned negative on the news, closed 4.3% higher at €72.63, against a 0.2% lower European chemicals index.

Merck expects the tie-up, funded from about €2bn in cash reserves and the issue of new debt, to yield annual synergy benefits of €260mn ($334mn) within three years after closing, by measures such as streamlining manufacturing, administration and research. It said it was too early to say if any jobs would be cut.

The deal would more than double the lab equipment unit’s adjusted core earnings, even without such synergy gains; including them, the increase would be 139%, based on proforma 2013 results.

“The fact that (the Merck family) are not taking a big step further into pharma shows that continuous returns on their investment over time are certainly important to the family,” said analyst Ulrich Huwald at brokerage Warburg.

At about €6bn in annual sales, Merck’s pharmaceuticals unit is well outside the global top 20, having suffered a series of drug development setbacks such as with an experimental cancer vaccine known as tecemotide, or Stimuvax, which did not come to market due to poor study results.

The group said yesterday that alliances, not major takeovers, would be the way forward for the unit. “The pharmaceuticals business (will) remain a good and solid mid-sized player”, Kley said.

Merck had earlier this year signalled that big pharma assets were on its radar and some analysts took a positive view on the fact it had steered clear of such moves.

Citi analyst Andrew Baum said in a note the acquisition came at a steep premium of about 30 times Sigma’s expected 2015 earnings per share, but argued the deal was better than buying a biotech or pharmaceutical asset given what he said was Merck’s “long-standing poor track record in pharmaceutical R&D”.

Merck, the largest maker of liquid crystals for TV and computer screens, made lab supplies a major pillar of its business when it purchased US group Millipore for $6bn in 2010. Combining with Sigma would make it one of the global market’s top three, the group said.

Merck’s biggest deal before this one was the takeover of Swiss biotech company Serono for €10.3bn.

Initial bridge loans to finance the deal will be replaced by about 4bn euros in bank loans and €7bn in bonds. Merck said strong combined cash flows would allow for rapid deleveraging.

Guggenheim Securities and JP Morgan advised Merck on the deal, together with law firm Skadden, while Morgan Stanley acted as financial adviser to Sigma-Aldrich, with Sidley Austin as legal adviser.