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Why Bayer's "Merger of Equals" Is More Like a Rescue Plan for a Loser

I hope Bayer (BAYRY) CEO Marijn Dekkers wasn't expecting anyone to take him seriously when he told Bloomberg that he is open to a "merger of equals" with another company, because such a merger would only benefit Bayer and would hobble the merged partner with Bayer's inefficiencies. Dekkers spoke the truth when he said:

I would be open to making the company stronger if the right opportunity were to come.
He's absolutely right. A merger with a company of comparable size would only make Bayer "stronger" because Bayer -- to put it in layman's terms -- sucks. Dekkers believes there are "three or four" companies that Bayer might merge with, but he didn't name them.

This chart (below) represents a basket of companies of similar size to Bayer. I have ranked them based on the amount of dollars (or euros) each company makes per dollar invested in sales, marketing and administration costs, which are usually a drug company's major quarterly expenses. The results describe how good each company is at turning a dollar invested in its people right now into a sale of the drugs it has on hand right now (click to enlarge):


Most drug companies can spin a dollar into $3 or $4 every quarter. Except for Bayer. Bayer is the sad blue line at the bottom of this chart, the company that frequently gets less than €2 per euro spent on the bulk of its operating expenses. The fact that its performance is so consistent says something about the company's margin-management, I suppose, but if Dekkers' people were any good at their jobs that line would be sloping upward. Even Pfizer (PFE), a company that's in the middle of a humiliating U-turn which will undo many of the mergers it made in the last 10 years or so, can get $3.66 on a dollar invested each quarter.

The entire pharmaceutical sector has been on a consolidation and efficiency drive since 2007, and the result is that most companies are bunching around the $3.40 mark. Their problem is that once a drug company reaches a certain size there are built-in inefficiencies, or diseconomies of scale, that no amount of cost-cutting can get rid of. (The more drugs you sell, the more drug factories, brand managers and lawyers you need to manage those sales. You can't just live without them.)

Yet Bayer has bucked even that feeble trend. If Bayer only became as good as the average company, it would still gain 75 percent more operating leverage than it has now. A merger, therefore, would likely make Bayer a better company only by pulling up the average efficiency of the combined company (but at the cost of the efficiency of the company with which it merges).

There is a case for this: Bayer would gain and the shareholders of the company it acquires would receive a premium on their stock. But the idea that Bayer is merging from a position of strength is risible. Dekkers said:

We have a relatively good pipeline compared with the rest of the industry, and we don't have blockbusters coming off patent either.
This is simply not true. Bayer recently lost patent exclusivity on its top-selling brand, the contraceptive Yaz. Yaz sales declined 16 percent to €242 million in Q1 2011 and is now merely its third-best selling franchise. Buyers beware.

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Image by Flickr user Ron Warholic, CC.
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