Faced with the financial muscle of rival Bayer, Merck KGaA has ducked out of the bidding for Schering AG.

Bayer’s 16.3 billion euro ($19.5bn) bid for Schering, announced with the full support of the latter’s management, trumped an earlier 14.9 billion euro hostile takeover bid by Merck. Observers are now waiting to see if another bidder emerges.

In a conference call, Schering chairman Hubertus Erlen said that the takeover bid by Merck made it clear that his company could not continue to operate independently, so negotiations promptly started with Bayer, its preferred partner,

Merck said it had decided that increasing its 77 euro-per-share offer for Schering was not justified, and that it would continue its strategy of ‘focused diversification based on the two strong pillars of pharmaceuticals and chemicals’, and intimated it may look at other ways to strengthen its business.

“We are still convinced that a combination would have been a good option for both companies,” said Merck chairman Michael Roemer.

Bayer has agreed to buy 86 euros a share for Schering, 12% more than Merck, to create a healthcare unit that would combine specialty pharmaceuticals, biologicals and over-the-counter medicines. Pharma will have annual sales of around 9 billion euros - out of total group sales of 15 billion euros - and be ranked 12th in the global marketplace.

Suggestions that Bayer and Schering should join forces have emerged numerous times in recent years. With the exception of Hoechst, which merged with France’s Rhone-Poulenc to form Aventis and was subsequently combined with Sanofi-Synthelabo in 2004, the German pharmaceutical sector has steered away from the consolidation that swept through the drug industry in recent years.

Bayer is Germany’s biggest drug company at the moment, yet ranks only 16th worldwide, and adding Schering to the portfolio will give it the critical mass needed to compete in the world pharmaceutical arena. The bid is also “the best way of reasserting the importance of Germany as a pharmaceutical industry base,” according to Bayer.

The pharmaceuticals unit will be called Bayer-Schering Pharmaceuticals and be based in Berlin, the site of Schering’s headquarters. The merger is expected to lead to around 6,000 job cuts, or 10% of the combined group’s workforce, although no divestment of Schering businesses is planned, according to Bayer chief executive Werner Wenning. There had been suggestions that suitors for Schering might sell off the firm’s medical imaging business

The two companies have a useful overlap in cancer drugs, while Schering brings a market-leading position in hormonal therapies, and particularly oral contraceptives, and Bayer will contribute a cardiovascular business. Both are focused on specialty, rather than primary care pharmaceuticals, which can be handled with smaller salesforces, tend to have higher margins, and are easier to defend in a competitive marketplace.

Schering also has a presence in the important US market for pharmaceuticals that belies its size via its Berlex Laboratories subsidiary, and a well-regarded pipeline, albeit one that has suffered a few setbacks in recent months.

Schering has an improved formulation of the widely-used cancer drug paclitaxel in late-stage clinical testing, as well as oral VEGF inhibitor PTK/ZK, also in Phase III, for colorectal cancer. Meanwhile, Bayer has potential blockbusters on its hands with Nexavar (sorafenib) for kidney cancer and the oral Factor Xa inhibitor, in trials for deep vein thrombosis and other thrombotic diseases.