Trading Merck Ahead of the Patent Cliff
Douglas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Big pharmaceuticals have the patent cliff, Ben Bernanke and the U.S. have the fiscal cliff and many investors simply want to jump off of a cliff.
While all the gloom and doom is not without some basis, it is important to remember that when one jumps off a cliff there are, in fact, two options, not just one. You can tumble to your inevitable death, or you can soar ever higher. The prospect for most major drug companies is neither as bleak as the alarmists predict nor as promising as my soaring analogy would suggest, but Merck (NYSE: MRK) is taking those steps necessary to at least target a soft landing.
The Patent Cliff
If you follow the pharmaceutical industry, you are familiar with some of the blockbuster drugs that are coming off patent this year:
- Pfizer’s (NYSE: PFE) best-selling cholesterol drug, Lipitor, lost its patent protection this year. Patients fill roughly 3.5 million prescriptions each month, and the drug was a significant source of revenue for Pfizer that has attempted both a discounting program and a strategic partnership with generic drug maker Mylan (NASDAQ: MYL) to stem the losses.
- Bristol-Myers Squibb (NYSE: BMY) lost patent protection for its key anti-clotting drug Plavix this year. The company is also attempting a coupon program to shore up revenues, but is relying heavily on other drugs to pick up the slack. Mylan is but one of the generics that has already hit the market.
- Merck’s asthma drug, Singulair, also lost patent protection this year. The drug constituted $1.43 billion of the company’s 2011 revenue stream. Merck is focusing on development of other options to fill the loss. Here, again, Mylan and others are moving quickly to offer generic options.
While each of the above cases will have an important impact on the revenue streams of each of the companies involved, it is important to remember than the expiration of a critical patent is not a new experience for any. While slapping a fear-mongering name on the expiration certainly makes the situation feel more dramatic, as long as major drug companies are able to create blockbuster drugs, they will have to deal with the expiration of the patents that protect these drugs. To suggest that any of the above companies is ill-equipped to manage such an eventuality is naïve.
Of the three companies above, only Bristol-Myers is not flirting with its 52-week high (see chart). The industry has been one of the strongest this year, and has outperformed the market. Despite the patent cliff, investors are voting with their capital and seem to keep buying most of the stocks in the sector.
Investing in the Future
Various companies in the sector have reacted differently to the patent cliff and to changes in year-over-year revenue. Despite an 8.7% decline in revenue, Pfizer slashed its research and development (R&D) budget by nearly 24%. The company seems to be more focused on strategic partnerships and acquisitions at this point than on internal development. Bristol-Myers reacted to its loss in revenue by increasing the R&D budget, more in line with what one would expect. Merck was one of the only companies in the sector that both saw an increase in year-over-year revenue and made an increase in R&D spending.
In addition to the R&D increase, Merck has been actively pursuing other means of insulating its revenues against patent loss concerns. Earlier this year, Merck acquired German cell culture media equipment manufacturer Biochrom AG, whose equipment is critical in the research process. The acquisition is expected to put Merck in a position to file for six or more major drug patents over the next 18 months.
The Trade
While many of the companies in the sector look strong, Merck’s proactive preparation to face losses associated with patent expirations is impressive. The company offers a 3.7% dividend yield, which adds an attractive income element to a very solid stock. Overall, the stock looks well positioned to perform at current levels and should make a solid addition to your core portfolio.
Mr. Ehrman has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.
