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Merck's Marginal Merger: $3.5B in Savings From Layoffs That Cost $3.3B

If you're an employee of Merck (MRK) and the newly merged Schering-Plough, the most crucial sentence in yesterday's Q4 2009 earnings release is this one:

The company also expects additional savings towards the synergy target to be generated in subsequent phases of its Merger Restructuring Program that will be announced later this year.
Sounds innocuous on its face, but in context that line is essentially the sound of Merck management sharpening its ax for further job cuts "later this year." (BNET previously discussed who was most likely to be laid off here.)

Merck said it was already progressing through its plan to lay off 15,000 of its 100,000 workforce while leaving 2,500 other positions vacant in a bid to achieve a "synergy target" of $3.5 billion in recurring savings per year, after 2012, from its operations. (CEO Richard Clark's helicopter appears to be exempt from the savings, however.)

This "synergy" is very important to Merck. We know this because Merck used the word four times in the five sentences it wrote to introduce its "merger restructuring program."

What is less clear from Merck's statement is how much waste the merger and the layoffs are creating. (I'm defining "waste" here as non-productive expenses that don't produce or sell drugs.) Here's a breakdown of some of the non-productive expenses for Merck in 2009. Merck's disclosure doesn't always make it clear if these expenses are overlapping or cumulative, so I'm listing them as Merck did:

  • Merger restructuring program: $1.4 billion
  • Merger related costs: $544 million
  • Other restructuring programs: $521 million
  • Restructuring costs, primarily employee separations: $1.6 billion
  • Total overall costs associated with restructuring programs included in materials and production, research and development, and restructuring costs: $2.0 billion
The costs are ongoing. Merck adds:
The first phase of the Merger Restructuring Program is expected to be completed by the end of 2012 with total pretax costs estimated at $2.6 billion to $3.3 billion.
You read that right: Merck is spending up to $3.3 billion in restructuring costs -- mostly layoffs -- in the hopes of achieving $3.5 billion savings, annually, after 2012. I won't bore you with a time-value-of-money theory, but if you factor in interest rates and lost opportunity costs you could argue that it might be more valuable to not incur those costs and just keep the $3.3 billion in bonds, at least for the next few years.

Sure, you can say that the restructuring costs are one-time affairs and that the real value kicks in after 2012. But the upshot is that the margin on these potential savings remains small, and everything has to go in Merck's favor in order to make them work. There appears to be no room for error.

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