Will Acquisitions Patch Merck's Pipeline?

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As Merck (NYSE: MRK) begins its fourth trial for its role in the deaths of patients who took its pain medication Vioxx, the company has announced plans to shore up its waning drug pipeline with a biotech shopping spree.

The New Jersey-based pharmaceutical firm is seeking big biotechs that can contribute both late-stage drugs and revenue to its financial statements; speculative start-ups need not apply. While CEO Richard Clark didn't specify the size of the companies under consideration, he noted that Merck has $15 billion in cash and $5 billion in annual free cash flows to fund any acquisition.

Last month, Merck announced that it would focus its business on nine core areas, including Alzheimer's, atherosclerosis, and cancer. In 2004, the company partnered with Celera Genomics (NYSE: CRA) to fund Alzheimer's research involving Celera's gene discoveries. Any drug would end up competing with the best-selling Aricept, co-marketed by Pfizer (NYSE: PFE) and Eisai (OTC BB: ESALY.PK), as well as Forest Labs' (NYSE: FRX) Namenda.

Zocor has been Merck's big-money atherosclerosis drug, bringing in some $4.5 billion annually. But it will lose patent protection later this year, allowing generics to move in and slash Zocor revenues by an estimated 50%. Merck has a partnership with Schering-Plough (NYSE: SGP) to sell a combination cholesterol-cutting drug involving Zocor, but it's also planning to directly compete with that drug by offering another product that combines Zocor with niacin. In addition, it still must contend with Pfizer's top-selling Lipitor.

Using such tweaked drugs has allowed some companies to extend their patents. GlaxoSmithKline (NYSE: GSK) was able to extend sales on its antidepressant Paxil, which lost patent protection in 2003, by introducing the one-dose-a-day Paxil CR. And Schering surprised generic drug makers by introducing an over-the-counter version of its antihistamine drug Claritin immediately after it went off patent at the end of 2002.

Either approach could help Merck maintain its edge, or regain it; the company still expects earnings to grow at double-digit rates through 2010. While Merck doesn't expect that growth to begin until 2007, those lofty goals have still raised some eyebrows, given the dearth of drugs in the company's pipeline. Acquisitions and partnerships could be the engine to drive that growth, while also preserving Merck's 4.6% dividend.

Even with its cash hoard, Merck faces a tough battle. It has thousands of lawsuits over Vioxx before it, and the company insists it will fight each one. The case under way in Texas says a patient died seven weeks after starting to take the drug, but three weeks after ceasing to take it. Merck contends that the risk for a heart attack does not escalate until a patient has been on Vioxx for 18 months. While no company should have to cave before the legal feeding frenzy of trial lawyers looking to capitalize on the drug's alleged problems, investors also can't overlook the litigation costs that will continue to eat into Merck's cash reserves and free cash flow.

A company can't buy everything, but then, it doesn't have to. A few key acquisitions that contribute late-stage drugs and significant revenue might be all Merck needs to keep its pipeline open.

Pfizer is a selection of Motley Fool Inside Value . Merck and GlaxoSmithKline are selections of Motley Fool Income Investor .

Fool contributor Rich Duprey owns shares in Merck and Eisai. He does not have a financial interest in any of the other companies mentioned in this article. You can see his holdings here. The Motley Fool has a disclosure policy.