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Buyout candidate a good buy


Dear Mr. Berko:

What’s going on with Schering-Plough? It used to be $60 a share just two years ago. Do you think this stock can recover from the current low $16 price by this time next year?  It really seems that Schering is down and out and it looks like it will stay that way for a while, even with its new chief executive officer. My broker wants me to buy 200 shares at this price because he thinks the stock could double in the coming 12 months. He’s very insistent I buy the stock, but frankly, I can’t see anything in the literature that speaks well of the company.

Please give me your opinion and let me know if I should take a 200-share position.

H.W., Joliet, Ill.

Dear H.W.:

It wasn’t long ago when Schering-Plough Corp. (SGP-$16) was traipsing down the Yellow Brick Road with swaggering confidence as it traded in the high $50s and low $60s.  Why not? Revenues in 1994 were $4.6 billion and SGP earned 60 cents a share. It split 2-for-1 in 1995 with revenues of $5.1 billion and earnings of 71 cents. In 1997, it split 2-for-1 again while revenues and earnings rose to $6.7 billion and 99 cents, respectively. Once more, in 1999, SGP split 2-for-1 and reported revenues for the year of $8.1 billion and earnings of $1.42.

Between 1995 and 1999, revenues grew from $5 billion to $9.1 billion, and net income more than doubled to $2.1 billion. In that same period, a 100-share purchase in 1995 at $60 ($6,000) exploded sixfold to 600 shares at $60 in 2000 – with a market value of $36,000. But during the following 24 months, a black cloud seemed to settle on SGP’s corporate headquarters and it’s been raining all sorts of problems since.

In April, Richard Kogan was finally replaced by Fred Hassan. Hassan is the guy responsible for returning Pharmacia Upjohn to good health and then persuading Pfizer to buy the company. Schering has some serious health problems, and Hassan may be the best doctor to cure them.

The most pressing problem is SGP’s bottom line, which is being eaten alive by competition. SGP’s flagship Claritin was forced off prescription and is now an over-the-counter drug competing with 57 other allergy nostrums. As a result, revenues from the sales of the drug were down 66 percent for the second quarter to $331 million.  SGP’s hepatitis-C franchise (Intron) is fighting Roche’s Pegasys and revenues were down 14 percent for the quarter to $569 million and looking lower. Zetia, the company’s cholesterol-fighting drug, needs a big push to ramp up revenues to its target base.

Then there’s some anxiety over SGP’s disclosure that it is the target of a grand jury investigation (criminal) concerning mislabeled medications, remuneration practices, improper Medicaid pricing and document shredding.

Recognizing that revenues for this year may be down 20 percent from 2002, and that earnings will sink to 48 cents per share from $1.34, Hassan wisely decided to cut the dividend to 22 cents from 68 cents. Because earnings for 2004 are expected to be even lower (45 cents per share), I wouldn’t expect the dividend to move back up for some time.

Even though SGP has zero long-term debt and $2 billion in cash, this move by Hassan will eliminate a negative cash flow of $250 million in 2003 and generate about $325 million in positive cash flow in 2004. He has frozen the company’s merit increases, initiated a voluntary retirement program, cut travel costs, eliminated most executive perks and reduced general expenses across the board. All of this should have been done two years ago.

These moves, as well as expected revenue growth from Integrilin, Proventil, Noxafil, Temador, Calyx and its dermatological products should stabilize SGPs revenues and earnings.   SGP is down and out, but it’s still got $2 billion in cash and about $8.8 billion in revenues anticipated for 2004. The shares are trading at a seven-year low and its big shareholders, including Vanguard, Fidelity and Wellington, are getting impatient.

Yes, I’d buy the stock, but not because SGP has a good product line or because I expect revenues and earnings to pick up nicely. I’d buy it because I think Hassan may successfully shop SGP to the competition, the same way he did Pharmacia. At current prices, SGP may be a takeover bargain. Perhaps that is why Raymond James issued a “strong buy” ranking on the stock in early September.

Listen to your broker. I think he’s giving you pragmatic advice.

Please address your financial questions to Malcolm Berko, P.O. Box 1416, Boca Raton, Fla. 33429 or e-mail him at malber@adelphia.net.

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