J&J vs. Merck: What Might A Remicade Settlement Look Like?

Analysts say Merck has a good chance of prevailing in arbitration over J&J's agreement with Schering to co-distribute Remicade but that the two parties may opt to settle.

An ongoing dispute between Merck and Johnson & Johnson involving J&J's $2 billion rheumatoid arthritis drug Remicade (inifliximab) and the next generation product Simponi (golimumab) looks likely to be resolved in the next two months.

Merck announced in a Sept. 7 filing with the Securities and Exchange Commission that an arbitration hearing will be held in New York City in late September to decide if Johnson & Johnson can terminate the distribution agreement with Schering, under which Schering obtained rights to the drugs outside the U.S. Merck said the hearing will last no more than 12 business days and a three-member panel will issue a decision within 20 business days after the conclusion of the hearing.

The implications of the arbitration are important for each company and for the anti-tumor necrosis factor market. But no matter what the outcome, it won't change the rationale behind Merck's acquisition of Schering last year.

Prior to announcing the proposed merger in March 2009, Merck and Schering devised an intricate plan to avoid triggering a change-of-control provision in the J&J-Schering agreement that allows the party not subject to a change of control to terminate the agreement. According to the 1998 contract, a change-of-control constitutes "any merger, reorganization, consolidation, or combination in which a party to this agreement [in this case Schering] is not the surviving corporation."

Under the reverse merger Schering was renamed Merck and continued to operate as the surviving public corporation. Merck contends that this prevents the change-of-control provision from kicking in.

"The Contract Itself Or The Spirit Of The Contract"

Analysts say Merck may have dodged the change-of-control provisions in the agreement by structuring its combination with Schering as a reverse merger. But some believe the parties may yet opt to settle. One hypothesis is that given the highly competitive anti-TNF market, J&J may want to avoid the risk of taking commercial responsibility for selling Remicade outside the U.S. For its part, Merck may wish to avoid the chance that an arbitration panel will focus on the intent behind the reverse merger rather than just the written terms of the J&J-Schering agreement.

"Merck is technically in a great position," Leerink Swann analyst Seamus Fernandez said in an interview. But "arbitration could go in either direction depending on whether the judges just rely on the contract itself or the spirit of the contract."

Fernandez said he suspects there will be a settlement unless J&J takes a hard line. If it takes too hard a line he said J&J will be at risk since the technical aspects of the contract were not triggered.

Middle Ground May Be Reached

Credit Suisse analyst Catherine Arnold said in a research note last year that Merck is likely to prevail but that J&J may likely get a "consolation prize (e.g., a higher royalty or a quid of some sort)." Bernstein Research analyst Tim Anderson also speculated that Merck could give up more economics on Remicade/Simponi or sell Schering's consumer health business to J&J at a discount (Also see "J&J Not Likely To Hold Its Peace At Merck/Schering Altar" - Pink Sheet, 16 Mar, 2009.).

In a note earlier this month Anderson said: "We (and consensus) continue to believe that the companies will settle the dispute or if it goes to arbitration that Merck will win, therefore a loss would be upsetting and could cause Merck's share price to contract by 5% or more, in our opinion." He added that it is possible that some sort of middle ground could be reached rather than a decision being all or nothing.

Merck also noted in the SEC filing that a settlement was possible. It said that any agreement to resolve the dispute "may result in the terms of the distribution agreement being modified in a manner that may reduce the benefits" of the agreement to Merck.

Merck noted that J&J is claiming damages "in an amount to be determined" and that it could be liable for the net damages, excluding any offsets or mitigation, that the arbitration panel finds J&J incurred as a result of non-termination of the agreement and suffer an impairment charge. Merck said an unfavorable outcome in the arbitration would have a material adverse effect on its financial position, liquidity and results of operations.

-Brenda Sandburg ([email protected])