Merck: Experts In Patent Cliff Management
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Merck (NYSE: MRK) is engaged in the development and manufacturing of medicines, vaccines, consumer health products, and animal products throughout the world. The vaccines prevent a large number of diseases such as measles, shingles, and mumps, while the prescription products are used in the treatment of cardiovascular and respiratory diseases, oncology, neuroscience and other areas. Consumer health products include Claritin for allergies, Coppertone for skin care, and Dr. Scholl's for foot care. In November 2009, the company acquired Schering-Plough Corporation, which has a strong product pipeline with very little exposure to the short term patent cliff. The acquisition goes some way to protect Merck, whose Cozaar/Hyzaar patent expired in 2010 and whose Singulair patent is set to expire in August 2012. Like the other healthcare majors, Merck is actively pursuing opportunities in developing markets and aims to generate 25% of its revenues from vaccines and medicines from these markets by 2013. It has set up an R&D headquarters in Beijing in China in which it plans to invest $1.5 billion over the next five years.
Merck has a patent cliff problem as seen with many major pharmaceutical companies, because drugs lose their patent protection after 20 years, which opens the market to much cheaper generic drugs. This problem has recently plagued competitors, as well, such as Pfizer (NYSE: PFE), which recently lost its patent exclusivity for Lipitor, AstraZeneca (NYSE: AZN) for Seroquel, Sanofi (SNY) for Plavix, Forest Laboratories (NYSE: FRX) for Lexapro, Bristol-Myers Squibb (BMY) for Zyprexa, and Eli Lilly (NYSE: LLY) for Olanzapine. In all these cases, there were substantial losses of revenue. Pfizer's income was nearly cut in half on the loss of its Lipitor patent. AstraZeneca's revenues fell 11% in the first quarter of 2012 due to the company not being able to block generic brands of Seroquel. Forest Laboratories saw its profit decline 79% on lagging Lexapro sales, due to an aggressively priced generic version of the drug.
In the case of Merck, the problem is its blockbuster drug Singulair, which will lose patent protection in August 2012. The drug is used to treat asthma and other allergies and brought in revenues of $1.34 billion in the first quarter. The challenge is to replace lost revenues when the patent protection expires.
Merck has five new products in the pipeline that could accomplish this objective, and the company says it remains on track and on schedule with respect to these products. The new drugs are Suvorexant for treating insomnia, Bridon, a neuromuscular reversal agent, V503, which prevents HPV associated cancers, Tredaptive a cholesterol medication, and Endocyte, a late stage oncology medicine. It is important for the company to obtain the necessary regulatory approvals to speed up the present 3% growth in its pharmaceutical business. The company has one product which received FDA approval earlier this year, Janumet XR. Janumet XR is a new treatment for type-2 diabetes that combines Januvia with extended-release metformin. These drugs are performing well and had 20% growth to $1.3 billion in the latest quarter. Merck also has other products for which patent protection is still available and revenues are growing. Moreover, the patent protection for Singulair will continue in Europe till early 2013 and in Japan till 2016.
Merck is pursuing partnerships that have the potential of providing future success through collaboration. It has recently signed a deal worth $303 million with Ambryx, a deal which should benefit both companies. The companies will work together to create what they describe as "rationally optimized biologic drug conjugates." Both companies have complementary skills in this area. It has also announced that it will collaborate in a multi-year project with Geisinger Health System for improving the outcome of patient health. This may not be a big deal in terms of revenues, but the company is demonstrating its responsibility to get patients involved with their treatments and increase the chances that they will adhere to treatment plans. Other competitors are recognizing the importance of such partnerships, and Sanofi is collaborating with the Joslin Diabetes Center to develop new treatments for diabetes and related disorders.
In its other business areas, Merck Animal Health has recently announced the approval in the US for its antibiotic ZUPREVO, which helps to treat BRD in beef and non-lactating dairy cattle and keeps beef operations viable and sustainable. In an effort to improve profitability, Merck is closing the Swiss headquarters of its Serono division. A rare negative for the company is the court ruling in its patent infringement dispute with Apotex for its Nasonex patent; the court has ruled that the patent is valid but that the product from Apotex does not violate the patent. This could mean competition in the future but you should remember that Apotex has not yet obtained FDA approval for its product.
The company spends around 15% of its sales revenues on research and development and intends to continue this proportion. This compares well with the 25% figure on overheads, such as advertising and management expenses, which is below the average for the industry. It has a sound financial position, a debt/equity ratio of 24%, and a AA debt rating from S&P.
As an investment, Merck seems to be undervalued, and, given its potential for growth and sound management, I would recommend the stock. The forward P/E ratio of the company is just over 10 at current prices, compared to ratios of over 12 for Johnson & Johnson (JNJ) and Eli Lilly, and an average of around 13 for the health-care industry. The company is moving quickly and decisively to deal with its patent cliff problem, and there is a whole clutch of promising new drugs that could be potential blockbusters. If you have an existing holding, you may choose to add to it judiciously if you have the appetite for further risk and favorable buying opportunities present themselves.
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