As a company that operates internationally and due to its presence in the capital market, Merck is exposed to various financial risks. These are primarily liquidity, default, currency and market-price risks, as well as risks of changing fair values of tangible and intangible assets, and fluctuations in the valuation of pension obligations.
Liquidity and financial risks
In order to ensure its continued existence, a company must be able to fulfill its commitments from operating and financial activities at all times. A central Group-wide liquidity management reduces potential liquidity risks. In addition, we have a EUR 2 billion syndicated multicurrency credit facility, which expires in 2014. This ensures Merck’s continuing solvency in case there should be any liquidity bottlenecks in spite of the Group’s positive operating cash flow. As our loan agreements do not contain any financial covenants, these agreed credit lines can be accessed even if Merck’s credit rating should deteriorate. In 2009, Merck set up a debt issuance program that forms the contractual basis for the issue of bonds. In 2010, the volume of this program was doubled from EUR 5 billion to EUR 10 billion.
Default risks
Default risks arise in connection with financial investments, loans and financing commitments as well as receivables in operating business. As a result of the financial crisis, the default risks for receivables in the eurozone have increased to some extent. Merck has therefore reviewed all its positions in the respective countries and taken precautions for default risks to the necessary extent. Merck minimizes these risks by spreading its financial positions and the associated active management of its trading partners. Significant financial transactions involving credit risk are only entered into with banks that have a good credit rating and a minimum rating of A- from Standard & Poor’s. In addition, Merck’s large banking syndicate – the existing credit line of EUR 2 billion was syndicated by 17 banks – reduces possible losses in the event of default. Nevertheless, the default of individual trading partners cannot be fundamentally excluded, even if they have an excellent credit rating.
Currency and interest rate risks
Due to its international business operations in different currency and interest rate regions, Merck is inevitably exposed to currency and interest risks. Merck is affected by market price risks owing to its global group structure and the associated financial transactions, receivables in operating business, as well as expected future cash flows from sales and costs in foreign currency. We use derivative financial instruments to minimize currency risks and financing costs caused by exchange rate or interest rate fluctuations. Financial transactions, receivables and liabilities recognized in foreign currency are generally hedged. In certain cases, the company also hedges anticipated sales and future costs for a period of up to three years. More information can be found in Notes (40) to (42) of the Consolidated Financial Statements.
Market price and market value risks
The values of individual items in the balance sheet are exposed to the risk of changing market and business circumstances and thus also to changes in fair values. The need for write-downs could significantly impact profit and lead to changes in balance sheet ratios. This applies in particular to the high level of intangible assets including goodwill, which have become significantly more important to the Merck Group due to the acquisitions of Serono in 2007 and Millipore in 2010. Further details can be found in Note (23) to the Consolidated Financial Statements.
Risks in connection with pension obligations
Merck has commitments in connection with pension obligations. The present value of these obligations can be influenced by changes in the relevant valuation parameters, e.g. the interest rate, salary increase rate or death probabilities. Pension obligations are regularly evaluated based on external actuarial valuations prepared annually. The majority of these obligations is covered by the pension provisions disclosed in the balance sheet, while the smaller remainder is externally funded or covered by long-term monetary investments made for this purpose and disclosed in the balance sheet. The latter amounted to EUR 217 million in 2010. As far as pension obligations are covered by plan assets consisting of interest-bearing securities, shares, real estate and other financial assets, decreasing or negative returns on these assets can adversely impact the value of the plan assets and thus require further additions to pension provisions. The risk of market fluctuations in the value of plan assets is reduced by a diversified investment strategy.
Assessments by independent rating agencies
The capital market makes use of the assessments published by rating agencies in order to assist lenders in evaluating the risks of a financial instrument. Merck is currently rated by the agencies Standard & Poor’s and Moody’s. In December 2010, Standard & Poor’s gave Merck a long-term rating of BBB+, with a stable outlook. In December 2010, Moody’s gave Merck a long-term rating of Baa2, with a stable outlook. Thus, both agencies confirm a stable investment grade rating for us.
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