Merck Spin-Off of Organon Targeted for 21Q2

In recent weeks, Merck has been following through on its plan to spin-off its subsidiary, Organon & Co., to shareholders.  On March 17, it filed its Form 10 registration statement related to the transaction.  On March 24, it posted on its investor relations website a lender presentation related to planned debt to be issued by Organon.  On March 30, it announced that it had agreed to acquire Alydia Health on Organon’s behalf.  On April 8, it issued a press release announcing the pricing of three debt tranches in a private placement.  The debt offering is expected to close on April 22.

Organon will hold an investor day on May 3 at which it will discuss and update its business outlook, strategy, financial structure and other issues relevant to investors and lenders.  A when-issued market in OGN will begin shortly before the record date of the spin-off, which will coincide with the SEC’s declaring OGN’s registration statement effective.  Merck anticipates that the distribution of OGN’s stock to its shareholders will occur before the end of 21Q2.

Organon is a global pharmaceutical company with prescription therapies grouped into three categories: Women’s Health (2020 pro forma sales of $1.6 billion or 23.8% of the total), Biosimilars ($0.3 billion, 5.1%) and Established Brands ($4.5 billion, 69.5%).  Other Organon product sales were $0.1 billion in 2020 or 1.6% of the total.

The company asserts that it is the only global pharmaceutical company that has women’s health as its primary therapeutic focus.  A substantial majority of its total portfolio consists of therapies that either uniquely or primarily impact women.  Its mission is to be the world’s leading women’s health company by investing selectively in internal development and external acquisitions, ventures, collaborations and partnerships in pharmaceuticals and other areas, such as medical devices.  It believes that it can achieve growth by pairing with local companies who would benefit from its global reach.

The Women’s Health portfolio today consists primarily of contraceptives and fertility therapies.  The portfolio is anchored by Nexplanon/Implanon NXT, a long-acting reversible contraceptive (LARC).  Women’s Health sales plunged 31% in 2020, due to the loss of exclusivity (LOE) on NuvaRing, a monthly vaginal contraceptive ring, and as a consequence of the pandemic. Organon expects to grow Women’s Health sales from a 2021 base by focusing on its Nexplanon/Implanon NT franchise. It believes that LARCs will gain global market share in the years ahead. It also has high hopes for Elonva, a once-weekly fertility therapy that replaces seven daily injections under the current standard of care.

The Biosimilars portfolio includes five immunology and oncology therapies, produced and marketed in a collaboration with Samsung Bioepis Ltd.  Under the arrangement, Organon has exclusive marketing rights in select geographies that vary with each biosimilar.  Sales increased 30% in 2020 and are positioned to grow, according to my estimates, at solid double-digit rates for at least the next few years.

Organon’s Established Brands portfolio includes 49 medicines, many of which were billion dollar blockbusters before they lost market exclusivity.  It key therapeutic areas are cardiovascular (e.g. Zetia and Vytorin), respiratory (Singulair and Nasonex), non-opioid pain, bone and dermatology (Arcoxia and Fosamax) and other (Proscar and Propecia).  Sales declined 12% to $4.5 billion in 2020, due to continued loss of exclusivity and the pandemic.  With most of the portfolio now past LOE, Organon believes that it can stabilize and even grow sales with targeted initiatives, such as introducing certain medications to new geographies, product line extensions and new drug combinations.

Organon estimates that the pandemic reduced 2020 sales by $400 million or about 6% on a pro forma basis.  The decline was due to fewer office visits (which hurt sales of physician-administered medicines), social distancing measures and delays in elective procedures.  As the pandemic recedes and daily life normalizes, the company should recapture those sales.

Outside of the sales boost from the passing of the pandemic, Organon believes that it can achieve low-to-mid single-digit annual growth in revenues through improved portfolio management, expected growth in biosimilar sales and developing or acquiring new products.  Sales will be down in 2021, due to the ongoing impact of the pandemic, mostly in the first half of the year.  Organon’s longer-term growth target is consistent with the consensus view of revenue growth for large cap pharmaceutical companies in 2022 and beyond (according to data compiled by S&P Global Market Intelligence).

On a pro forma basis, Organon had 2020 net income of $1.5 billion and adjusted (non-GAAP) net income, which mostly excludes one-time formation costs, of $1.77 billion.  It expects earnings to decline again in 2021 (in contrast with peers, whose earnings on average are projected to bounce back double-digits), before rebounding at a low- to mid-single digit annual rate in 2022 and beyond.  Although Organon’s portfolio is much more heavily weighted to medicines that have lost exclusivity and sales have declined for at least the past two years, it is not unreasonable, I believe, to value the company at the starting gate at the middle of its peer group range of roughly 9-16 times projected 2021 earnings (with a mean of 12.6).  With preliminary projected 2021 adjusted earnings of $1.41 billion, I anticipate an equity valuation of about $18 billion for Organon, which equates to about $7.10 per Merck share.

The valuation will of course depend upon the market’s reception of the new equity.  If investors fixate on the steady historical sales declines, the valuation could conceivably be lower.  On the other hand, investors who emphasize ESG-related issues may effectively bid up the initial valuation of a company that is dedicated to women’s health.

Furthermore, Organon’s strategy has a great deal of optionality.  The company could look quite different five years from now as a result of inorganic expansion (acquisitions of companies and/or product lines, collaborations, partnerships, joint ventures, etc.).  Merck provided a hint of what might come by announcing on March 30 an agreement to acquire on Organon’s behalf, Alydia Health, a medical device company focused on preventing deaths caused by postpartum hemorrhaging and abnormal postpartum uterine bleeding.  If the market foresees positive strategic developments, it may bid up Organon’s share price in advance, raising its valuation in anticipation of future revenue and earnings growth that would be higher than expected, given the erosion in recent years of its sales and profitability.

My current performance rating of “moderately outperform” is based upon my estimated $18 billion post-spinoff equity value. Obviously, I may have to revisit this rating, if the stock trades at a meaningfully higher or lower value out of the gate.

This is a summary of a detailed, 20 page analysis of Organon & Co. that I published recently. That report is available to interested investors upon request.

I currently have a long position in shares of Merck & Co.

April 15, 2021

Stephen P. Percoco
Lark Research
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