R.P. Scherer

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R.P. Scherer

2075 West Big Beaver Road
P.O. Box 160
Troy, Michigan 48099
(313) 649-0900

Public Company
Incorporated: as Gelatin Products Corporation in 1944
Employees: 2,400
Sales: $167 million
Market Value: $131 million
Stock Index: NASDAQ

The R.P. Scherer Corporation manufactures encapsulation products for the pharmaceutical and nutritional health industries. With a long history of industry expertise, the company commands over 60% of the worldwide market for soft elastic gelatin capsules. Scherer similarly produces a major share of two-piece fused hardshell capsules, popular among drug companies as pharmaceutical encasements. In recent years, however, competition from drug companies manufacturing their own capsules has reduced Scherers hardshell business. The increasing demand for soft-shell capsules, principally through the growing vitamin market, partially compensated for the decrease in sales. Acquisitions outside the area of capsules also served to broaden the earnings base. Yet internal management disputes and unreliable markets have prevented the company from regaining its former position. Only with the recent introduction of MaxEPA, a highly regarded fish-oil capsule, has there been hope of improvement.

Robert Pauli Scherer was born in 1907, the son of an eye specialist. In 1930 he received a degree in chemical engineering from the University of Michigan. After a brief period of employment in a pharmaceutical company Scherer resigned and devoted himself to developing a capsuling machine. Working in his fathers basement metal shop for three years, Scherer eventually patented his machine and revolutionized the pharmaceutical industry. A model of Scherers rotary die process machine is presently on exhibit at the Smithsonian Institution in Washington.

Using his newly invented machine, Scherer formed the Gelatin Products Company. Immediately successful, the new company soon secured business with a growing list of pharmaceutical manufacturers and in 1947 adopted its present name. While claiming nothing he had ever accomplished could be considered work, the young company leader found himself managing a multinational corporation with subsidiaries operating in Canada, Europe, and South America. Always searching for new products to encapsulate, Scherers entrepreneurial spirit led him to experiment with such unusual mediums as insect repellent and lighter fluid.

At the age of 53 Scherer died, passing company leadership to his son Robert P. Scherer Jr. From that time until the mid-1970s the operation of the Scherer corporation seemed secure. Its virtual monopoly on the soft gelatin market increased the companys stock to a high of $40 per share.

As events would soon show, however, Scherers control of the market became threatened when the rising cost of gelatin compelled pharmaceutical companies to seek less expensive ways to compress their products. Similarly, an expected sales increase resulting from the companys own product, Vitamin E, did not materialize, and a strong dollar overseas had adverse effects on the nearly 51% net income derived from foreign operations. In response to a plunging stock price and a leveling of profit margins earned from encapsulation, Robert Scherer embarked on a program of diversification through acquisition. In search of purchases which provided access into the growing medical equipment market, Robert Scherers company soon acquired Storz Instruments Company and Surgical Mechanical Research Inc. This latter purchase incurred, for the first time, a long-term debt totaling $1.6 million.

In addition to medical equipment, the company also operated a hair care business. To augment growth in new areas, Robert Scherer hired a management team recruited from large industry competitors. James A. Cormack, former chairman of Johnson & Johnsons Ethicon division, joined Scherer in 1976 as president and chief operating officer. Other recruited executives came from such diverse companies as Miles Laboratories and American Natural Resources Company.

By 1977 Scherers gelatin capsule operations, increasingly dependent on the nutritional health industry, experienced a revived market participation. Some 73% of the gelatin capsule sales came from vitamins produced in Scherer facilities. Similarly, profits from the Storz Instruments subsidiary exhibited a profit increase of 23% in the third quarter. A 1979 purchase of First Texas Pharmaceuticals included the addition of new products for encapsulation as well as an opportunity to market vitamins for the first time under a brand name. In an apparent show of company support, Robert Scherer purchased 22,600 shares of his companys stock which increased his personal holdings to a 10% interest. Several other Scherer executives followed the chairmans lead in purchasing common shares.

Despite such a promising outlook, internal disputes soon exposed numerous company problems. An unfortunate purchase of a hardshell capsule factory formerly owned by Scherer officer and director Stephen Lukas was beset with problems concerning inventory and quality control. Consequently, an unusual countersuit between Lukas and the company alleging such unseemly occurrences as price-fixing and delinquent payments resulted in an acrimonious exchange of accusations. While all claims were eventually dropped, the damage surrounding company credibility lost numerous customers.

Not only was the company reputation damaged during this period of upheaval but discontentment about Robert Scherers job performance surfaced in an unusual public announcement. Although the holdings of the chairman and his family together comprised a 74% interest, and a noticeable portion of Scherers board of directors were family members, nevertheless Robert Scherer was not protected from being ousted by the board. Increasingly critical of Scherers allegedly indifferent attitude towards the business, including the frequent use of the companys Lear Jet for non-business purposes, the board took action by arranging to split the company in two. The board gave Robert Scherer control of a small privately held company comprised of Scherers medical equipment and hair care subsidiaries in exchange for the chairmans 21% interest. Since these subsidiaries represented a 21% contribution to sales and earnings, the agreement offered a fitting solution to a growing quandary.

One person especially in favor of the company split was Heiner Koepff, the 49% owner of Scherers West German gelatin supply operation. In 1979 nearly half of Scherers profits were generated from the West German facility. Thus Robert Scherers program of diversification resulted in a business entirely unlike and separated from the foundation laid down by his father. Peter R. Fink, Wharton graduate and son-in-law of the later Robert Pauli Scherer, now assumed the role of president while Wilbur Mack assumed the vacated chairmans position.

As president Fink turned his attention to the immediate rectification of the companys earnings figures. He invested $70 million in upgrading and expanding operations and increased Scherers research expenditures to $2.5 million. Although confronting a growing long-term debt, nevertheless the company registered a 6% earnings gain on sales between 1981 and 1982 and an almost doubled profit margin. Wall Street analysts suddenly showed renewed interest in the company.

No sooner had the new management started attending to business, however, when the company was forced to fight a takeover attempt. In July of 1982 FMC Corporation, a large Chicago conglomerate, offered $22 a share to acquire 4.1 million or 52% of the total common stock. While some of the founding family members showed interest in the bid, Fink successfully prevented any such action; his proposal requiring an 80% shareholders approval for a merger to occur received ratification.

After the merger episode had subsided, Scherer stock began trading at 13 times earnings; this was in response to the excitement generated from an agreement with Merck to develop suppositories for drugs previously available in injection form. At the same time, the company benefited from a bizarre and tragic event. In September of 1982 Johnson & Johnson, a hard-shell capsule customer of Scherers for years, became the victim of product sabotage when it was discovered that the extra-strength analgesic Tylenol had been laced with cyanide. While only 15% of Scherers total volume was generated from the hard-shell business, nonetheless, Johnson & Johnsons decision to stop manufacturing Tylenol did have its repercussions for the encapsulation manufacturer.

Due to the fact that soft one-piece capsules represented a virtual tamper-proof casing, Scherers market position as the largest manufacturer of soft elastic gelatin capsules took on new significance. Should pharmaceutical companies search for new protective methods of packaging their products, Scherer was prepared to meet the increased demand. Wall Street analysts, recognizing the companys potential expansion, began predicting an annual growth rate of 15-20%. By 1984, however, disappointment replaced optimism. Citing extenuating circumstances surrounding the strength of the dollar on the foreign market and initial expenditures invested to start new facilities in Utah and the United Kingdom, Scherer reported a 42% decline in earnings for the first quarter.

While the financial community became increasing skeptical, Fink remained confident in his companys future. The initially large investments for the new facilities decreased. Furthermore, the market for health and nutritional products, now comprising a major portion of Scherers sales, was said to be increasing. Some 80% of Scherers sales were in the soft capsule business, of which 75% were used to encapsulate vitamins and health foods in the U.S. Approximately 25% of total sales came exclusively from the sale of Vitamin E.

Finks optimism, however, could not prevent the mounting skepticism. The nutritional market, inherently more cyclical than the pharmaceutical market, represented a fluctuating array of trends. When pharmaceutical companies began to rely less and less on Scherers products and more in favor of synthesizing their own tablet form of vitamins, Scherer was forced to depend more heavily on the health food market. Yet when, for example, the Vitamin E trend collapsed, Scherer experienced a 43% decline in sales of their formerly popular product.

In regard to ethical drugs, a 1986 estimate reported that only 2% of all oral medications were packaged in soft-shell capsules. The Tylenol tragedy did not, as was hoped, increase demand. With Johnson & Johnsons decision to sell the analgesic in tablet or caplet (capsule-shaped tablets) form only, the announcement all but extinguished predictions of a soft-shell encapsulation increase. Hardshell capsules remained more popular among pharmaceutical companies. Yet intensified competition between companies manufacturing hard-shells, including the recent participation of the Warner-Lambert Company and Eli Lilly, resulted in a price-cutting war. After this intense competition had ended, Scherer posted a $3.5 million charge against earnings for closing its new Utah plant. Another area of significant vulnerability surrounded Scherers 70% volume on foreign markets, making the company increasingly subject to fluctuations in monetary rates.

In order to remedy such glaring deficiencies company management implemented a consolidation program. By reducing overhead costs and diversifying production through the recent purchase of the Lorvic Corporation, a manufacturer of dental supplies, Scherer hoped to regain lost ground. Finks plan to make further acquisitions in the health care field indicated a shift away from dependence on the sale of soft-shell capsules. Furthermore, the remaining encapsulation business was now directed toward the proprietary and over-the-counter drug markets such as cough-syrups and antacids as well as prescription drugs. Research on freeze-dried tablets that dissolve quickly represented a potential new market for children and the elderly.

Scherers most promising product, however, is the innovative new health food product called MaxEPA. This encapsulation of fish oil is generating a good deal of excitement in the medical community as numerous studies now reveal that a diet high in fish oil can help prevent hardening of the arteries as well as offer relief to sufferers of a wide array of ailments, including arthritis and cancer of the breast and prostate gland. Receiving rather encouraging support from 13 medical journals, the widening recognition of MaxEPAs potential therapeutic qualities sent Scherers stock up to $15 per share from a low $9 per share.

With the company poised to introduce MaxEPA in numerous overseas markets, industry analysts presently believe that in a short matter of time Scherer will be arranging its worldwide business with a major drug company. This future partnership could signify Scherers maturity as a fully integrated health care company. In a significant shift from just several years prior to MaxEPAs market entrance, Scherers stock is now recommended as a high-growth investment. It will be a few years, however, before the new nutritional supplements true market potential is revealed.

Principal Subsidiaries

The Lorvic Corporation; Franz Pohl GmbH (W. Ger.). R.P. Scherer also has subsidiaries in the following countries: Argentina, Australia, England, France, Italy, Canada, Brazil, Hong Kong, and Korea.