Merck Shrugs off Patent Worries, Eyes China

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The German employees of Merck (NYSE: MRK) are facing layoffs while the company is expanding its base in China. It has recently entered into a joint venture agreement with Simcere Pharmaceutical Group (NYSE: SCR) to provide high quality branded drugs to the Chinese market. Their joint operations will include R&D, manufacturing and sales with a focus, initially, on the growing number of chronic diseases, particularly in rural China. The country witnesses nearly 260 million chronic disease cases each year, out of which nearly 2 million people die. The new JV, called Simcere MSD, will use the existing plants of Merck and Simcere in the first phase to manufacture drugs. The new operation is also in line with the government’s policy to expand medical insurance coverage to the entire rural population by the end of the year.

Simcere claims to be “one of the leading” Chinese pharmaceutical companies that develops and markets branded and proprietary drugs. But its market cap is approximately $400 million and is nowhere the size of the Chinese majors such as Sinopharm with a market cap of $7.4 billion or Shanghai Pharmaceuticals at $5 billion. By comparison, Merck’s quarterly sales last quarter were $12.3 billion. To say that China’s pharmaceutical sector is highly underdeveloped with respect to the market’s needs would be a major understatement. 

The Chinese healthcare market is expected to grow rapidly in the next couple of years and will reach the $1 trillion mark by the end of 2020. The government has also increased the health budget from 5.5% of GDP to 7%. The prescription market that stood at $50 billion in 2010 crossed $110 billion in 2011. Furthermore, the government’s favorable tax legislation is also inducing foreign companies to produce drugs in China, where manufacturers generally enjoy a lower labor cost.

All the leading drug manufacturers such as Pfizer (NYSE: PFE), Novartis (NYSE: NVS) and GlaxoSmithKline (NYSE: GSK) are aware of this and, while they continue to downsize the North American and European business units, they are partnering with domestic firms; expanding their R&D and sales force. Pfizer is already working with Shanghai Pharmaceuticals and Zhejiang Hisun Pharmaceutical. Novartis is focusing on the vaccine market and has planned a five year $1 billion R&D investment program for China while it acquired an 85% stake in Zhejiang Tianyuan Bio-Pharmaceutical. GSK, on the other hand, is initiating R&D in Traditional Chinese Medicine while expanding its 4,000 strong sales force in the country.

One of the biggest threats that the Big Pharma corporations face is the loss of exclusivity due to expiring patents of successful drugs. Out of the two top drugs that Merck sells, one has already lost its patent while the other one will be lost by the end of this year. Up until 2011, Singulair was Merck’s prized jewel that earned it $5.5 billion in sales, more than 10% of the total revenues. However, it lost its exclusivity in the previous month. While Maxalt, that bagged $639 million, will lose patent protection in December 2012. The type-2 diabetes drug franchise Januvia/Janumet is growing at such an impressive pace that, to a great extent, it alone might offset the decrease in revenues from the loss of the two patents. So far, Merck expects to earn $5 billion from Januvia/Janumet by the end of the year.

The type-2 diabetes is a $23.7 billion market which is expected to double by 2020. Merck’s drug is quickly emerging as the market leader in 2012. Analysts have estimated that by 2018, Januvia/Janumet will become the number one selling drug in the world with sales reaching $9 billion. However, the company’s survival does not and should not depend on just one drug. Merck’s has its pipeline filled and is expected to file for FDA approval for six or seven drugs between 2012 and 2013. Chances are that at least one of them will be able to increase the company’s revenue. That, coupled with Januvia/Janumet’s performance, should be enough to make up for the loss of Singulair and Maxalt.

In the half yearly filings for the current year, Merck earned 43% of revenues from U.S., 25% from Europe and 12% from Japan. From China, Merck earned $484 million, or 2.3% of total sales, in the first six months, rising from previous year’s $393 million in the corresponding period, a 23% increase. China is the fastest growing market from both a sequential and year-on-year basis.

Merck has risen by 18.2% since the beginning of the year, with most of the growth coming after June, once it became apparent that the company will achieve its year-end targets and the Supreme Court upholding Obamacare, a piece of legislation written by the medical-industrial complex in the U.S., despite the loss of patents. So, with that ruling, a legislative moat built around their drug sales and the pipeline full of new products, Merck should continue to line investors’ pockets while it profits from the unhealthy lifestyle choices of a rapidly-aging U.S. population.  Any growth they see in China then can almost be seen as gravy and potentially explosive to their bottom line.

Currently trading at a P/E of 20 but carrying a 4% yield, Merck looks like good value for the long haul.   The recent break out above $40 per share was a major technical achievement signaling that the price should be ready for a long and profitable run from here, especially with the dividend being raised to support the yield which signals management is confident of future growth.


PeterPham8 has no positions in the stocks mentioned above. The Motley Fool owns shares of GlaxoSmithKline. Motley Fool newsletter services recommend GlaxoSmithKline. 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.

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