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Watson Plans Schein Buy as Big Generic Drugmakers Look to Beef Up

The feeding frenzy is on among generic drugmakers.

That's the message behind Watson Pharmaceuticals' (WPI) planned $664 million buy of Schein Pharmaceutical (SHP), whose long-suffering shareholders sent Schein shares up 22% at the prospect of cashing out. Watson, casting itself as an acquirer in an industry where analysts expect to see significant consolidation, saw its shares slide 14% on the news.

The cash-and-stock deal will end Schein's dismal saga in the fast-growing $9 billion generic drug industry and give Watson greater scale, better to compete with rivals such as Mylan (MYL) and Teva (TEVA - Get Report). In combining Schein, the ninth-biggest U.S. generic-drug firm, with No. 6 Watson, the deal puts the merged Watson just below Israel's Teva, the top generics firm with $1.2 billion in 1999 sales and a voracious appetite to consume rivals.

Keying on Distribution

Watson's move, which came after Schein put itself up for sale in January, follows a series of acquisitions among second-tier, "specialty" pharmaceutical companies. Recent acquisitions include Teva's buys of Copley and Novopharm, Shire's (SHPGY) acquisition of Roberts and Galen's recent offer for Warner Chilcott (WCRX).

Analysts say generic-drug companies are all looking to better appeal to large drug buyers like health maintenance organizations by offering a wider range of products and services. Watson's move will give it about 14% of the market for generics, where size is increasingly important.

"We continue to believe the emerging pharmaceutical and generic sector will continue to consolidate, similar to the large-cap pharma industry," says Jeff Kraws, drug industry analyst with Gruntal, which doesn't underwrite for the drugmakers. All companies, says Kraws, are looking to be "larger, stronger and have greater distribution."

Shaking Out
Generic drug companies gird for consolidation
Company 1999 revenue (millions) Recent price P/E ratio* Market cap (millions)
Teva (TEVA:Nasdaq) $1,200 47 1/2 49 $5,910
Forest (FRX:NYSE) 892 87 1/2 68 $7,382
Mylan (MYL:NYSE) 790 27 1/4 22 $3,524
Perrigo (PRGO:Nasdaq) 776 6 18 $438
Alpharma (ALO:NYSE) 774 48 1/2 34 $1,448
Watson (WPI:NYSE) 710 42 16 $4,043
Ivax (IVX:NYSE) 691 33 1/2 63 $5,203
*Trailing 12-month price-to-earnings ratio. Source: Yahoo! Finance.

Generic drug companies, which leapfrogged to claim 41% of the nation's $74 billion drug market in 1999 from a slender 18% in 1984, are all maneuvering to benefit from a raft of branded drug patent expirations in the next five years, which include major blockbuster drugs like Merck's (MRK) cholesterol-fighting Zocor and AstraZeneca's (AZN) heartburn drug Prilosec.

Emboldened by recent court wins such as Ivax's (IVX) victory against Bristol-Myers Squibb (BMY) over the anticancer drug Taxol, generic drugmakers are lining up to sue drug companies and bring cheaper generic versions of drugs to market. In addition, generic drugmakers are expected to be the prime beneficiaries of any prescription drug benefit plan that Congress could enact in the next two years.

Schein off the Apple

Schein, which is about 25% owned by Bayer, has been hobbled in recent years by a series of major run-ins with the Food and Drug Administration over a raft of failures to comply with drug manufacturing rules. Its shares hit a low of 7 5/8 last January, but closed Thursday at 20 3/16.

Last July, Schein shut down manufacturing at its Cherry Hill, N.J.-based Marsam unit after an FDA inspection. The company recalled products and took a charge of $87 million for the episode. Marsam, which Watson said it plans to divest, hasn't yet resumed full operations.

The Marsam shutdown was remarkable in that came a year after the FDA took the extreme step of seizing all products and shutting down operations at another major Schein unit, Steris Laboratories, which accounted for 40% of sales in the first six months of that year. The company took a 1998 charge of $161.2 million after the fiasco.

Like Marsam, Steris also hasn't resumed full operations and sales and profit suffered from both incidents. In the first quarter, Schein revenue fell 17% to $87.9 million from the previous first quarter, sending operating profit down 47.4% to $36.3 million.

The company in January said it hired financial advisers to consider "strategic alternatives" including a sale of the company. It recently settled a lawsuit brought by shareholders representing about 50% of the company -- including descendants of founder Marvin Schein -- over charges that officials were seeking to "enrich" themselves after a "dismal performance" and block any sale of the company.

Watson said Bayer and the Schein family, which together hold about 74% of the stock, agreed to the offer.

Teva on the Prowl

Corona, Calif.-based Watson's move is likely to be closely watched by Teva, which sells 150 products, including both generic and branded drugs, such as Copoxone, a leading multiple sclerosis drug.

Since 1990, Teva has leapfrogged into first place among generic drugmakers through four major acquisitions -- half of Lemmon and all of Biocraft, Copley and Novopharm -- for a total of $776 in cash and stock. The company has said it's still hungry.

"We will soon be ready for another acquisition if an opportunity avails itself," warned Teva CFO Dav Suesskind at a UBS Warburg specialty pharmaceuticals conference in New York Tuesday.

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