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Drugmaker Schering-Plough dropped a bombshell on Feb. 15 when it revealed that the U.S. Food & Drug Administration has found several of its plants have subpar quality control. Since then, the company has kept mum on the exact nature of the problems and how long it will take to fix them.
Result: A fog of confusion shrouds Schering, and the company's silent treatment is spooking investors. Its stock (SGP
) has fallen some 20%, to the low-$40 range, since the bad news was unleashed. And ongoing uncertainty is always a warning flag that shares could go further south. "We're surprised it's trading this high. We think the Street is being optimistic," says Ken Nover, an analyst with A.G. Edwards & Sons who downgraded the stock to a hold rating following the bad news.
Schering is now being hit by shareholder suits charging that it misled investors. The company denies the charges, but spokesman Bob Consalvo says, "Obviously, the [FDA] issue will have an impact on sales and earnings, and that speaks to the seriousness of the overall manufacturing issues. We're working with the FDA as we speak."
RIPPLE EFFECTS. Quantifying Schering's potential shortfall, however, is guesswork, because the company has offered few specifics about its problems. With its production reduced, Schering says first-quarter 2001 earnings per share will fall short by as much as 15% from last year's 42 cents per share. Full-year results also could be hit by the manufacturing issues, the company says. Last year, Schering's earnings jumped 15%, to $2.4 billion, on sales that were up 8%, to $9.8 billion.
The extent of the damage will depend on when and how Schering comes to resolution with the FDA. Richard Evans, an analyst with Bernstein Research, recently cut his 2001 earnings-per-share expectation to $1.78, from $1.92 previously. Evans, who is in the camp that recommends buying Schering stock on the possibility that a rival may swoop in and buy it, also lowered 2002 earnings expectations to $2.15, from $2.17.
The ripple effects could indeed last well beyond this year. Schering has said it will be able to provide enough Claritin, its blockbuster allergy medication, for this spring and summer. But analysts wonder if it will be able to produce enough of its other products.
Worse yet, Schering's follow-up version of Claritin, called Clarinex, cannot be approved until the FDA clears the company's troubled plants. And with Claritin responsible for 30% of Schering's sales, generic competition is a major concern since the drug loses patent protection next year. Clarinex was supposed to offset the loss of Claritin sales.
RIPE FOR TAKEOVER? Actually, FDA inspections and letters of dissatisfaction with manufacturing processes are fairly commonplace in the pharmaceutical industry. What's unusual is for the complaints to be serious enough to interrupt production lines for some drugs and lead to delays of drug approvals, as Schering has warned.
The manufacturing problems began in 1999, when regulators sent the company warning letters about quality control of its aerosol products. Schering has been addressing the FDA's concerns since then but appears to have fallen behind the curve in resolving the issues. "Schering is a well-run company, looking at their regulatory history, but there was a fair amount of tension with the FDA," speculates Evans. "Schering made a judgment error as it got into the later phases of negotiations with the FDA, and the FDA decided to become quite a bit more aggressive."
Given how long it usually takes the FDA to act, a tidy, definitive conclusion of this case may not arrive soon. "This will certainly take time," says Tim Ghirskey, senior portfolio manager at Dreyfus Corp. He expects the FDA issues may not be resolved until the third quarter.
The question now is whether Schering is takeover bait. The company says no. "We don't feel we need to enter a merger to be a successful company," says Consalvo. "We've been successful in the marketplace adhering to a strategy that has been in place for years." And some analysts agree a buyout is unlikely. "If we really thought [a takeover] would happen, we'd own a lot more of it," says Ghirskey.
POTENT COMBOS. Nonetheless, the usual suspects -- American Home Products (AHP
), Novartis (NVS
), Johnson & Johnson (JNJ
), Merck (MRK
), and Roche Holdings -- are being batted around by analysts as possible acquirers. But there would be considerable risks, even with Schering shares down so far. Even before the latest manufacturing issues, the company was hobbled with the prospect of the Claritin patent loss and skepticism that the follow-up drug, Clarinex, would be a big seller, since some analysts speculate it might offer only a slight improvement over its predecessor.
Merck, which has a partnership with Schering for two products, would be the most likely buyer, analysts guess. But fiercely independent Merck discourages talk of a Schering buyout. "Our strategy has not changed at all, regardless of the current circumstances with Schering," says a company spokesperson. The agreements set last May to combine Merck's Zocor with Schering's upcoming ezetimibe to combat cholesterol along with the anti-allergy coupling of Claritin and Merck's Singulair remain intact. Merck, however, still intends to go it alone, "without mergers or acquisitions," the spokesperson says.
Schering's primary focus is on pharmaceuticals for allergy and respiratory diseases, cancer, and infectious diseases. Prescription drugs account for about three-fourths of its total sales, with additional revenues coming from its products in animal health, foot care, nonprescription drugs, and sun care.
Despite investor worries over Clarinex, Schering has other cards to play. The company, which is already the dominant player in the hepatitis-C market, launched its improved interferon, called Peg Intron, with Enzon (ENZN
), last month. Analysts are quite bullish on the product, which Schering hopes to market with its anti-hepatitis-C drug ribavirin upon FDA approval of the combo treatment sometime in the third quarter of this year.
WORTH A FLUTTER? Richard Stover, an analyst with Arnhold & S. Bleichroeder, calls the Peg Intron and ribaviron franchise, "the driving element" for the company, and he expects the combined therapy to be the new standard of care for the disease. Stover estimates sales of Peg Intron and ribavirin, combined and on their own, to reach their peak in the middle of this decade, selling $4 billion to $5 billion.
Throwing a wrench in Schering's hold on the hepatitis-C market is Roche's improved interferon, called Pegasys, which looks to be comparable to Peg Intron in terms of safety and efficacy. Pegasys should reach the market in the middle of this year. But Schering should be able to block Roche from promoting Pegasys and Schering's ribavirin as a combined treatment since the company has a patent that covers the use of all interferon with ribavirin, Stover says.
Schering is also close to FDA approval for Asmanex, an inhaled steroid treatment for asthma that has a low level of absorption outside of the respiratory system. Stover expects approval sometime this year. Next in the pipeline is ezetimibe, the cholesterol-lowering agent that Schering and Merck will market together with Merck's Zocor when the combined therapy is approved. Stover estimates approval for ezetimibe alone in 2002, with the combined treatment probably passing the following year.
OUT OF BALANCE. Drug stocks are generally seen as low-risk, low reward bets. Trouble is, when a company is in Schering's predicament, shareholders suddenly start to wonder if the wager is worth making. Schering has established products in a focused set of therapeutic areas, a strong presence in the U.S., and attractive licensing and marketing deals with biotech companies. But such pluses aren't enough to offset the problems that plague the company.
"The question is, how much faith do you have in a situation with no certainty?" says Greg Aurand, manager of the Munder Multi-Season Fund. Unless you enjoy leaping into the unknown, Schering is one pharmaceutical stock investors might want to pass on for now.
Tsao covers biotechnology issues for BusinessWeek Online. Follow The Biotech Beat every week, only on BW Online Edited by Thane Peterson
Copyright 2001 , by The McGraw-Hill Companies Inc. All rights reserved.
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