Merck Further Refines Its Future

Source: Merck.

Continuing its journey to be a top research and development drug company, Merck  (NYSE: MRK  ) agreed to sell to Germany's Bayer  (NASDAQOTH: BAYRY  ) its consumer care business for $14.2 billion. This deal gained a lot of traction last week and will have the pharmaceutical giant focusing on the discovery and sale of new drugs.

Inherited from its acquisition of Schering-Plough in 2009, the consumer care division accounts for $1.9 billion of Merck's total revenue of $44 billion. But that's down 3% from the year-ago period, and a quarter of those sales came from Claritin, its over-the-counter allergy treatment, according to Bloomberg News.

Merck is faced with the loss of patent protection on a number of its biggest drugs, and the pharmaceutical reported in February fourth-quarter revenues took a hit. Although they came in line with Wall Street expectations, they were down 7% from last year and the first-quarter results it recorded last week showed revenues were down 4% more as generic competition for previous blockbuster medications like Singulair took its toll.

Worse, Merck's pipeline of new drugs has often proved to be an inconsistent source of hits, so that its decision to divest itself of non-prescription and consumer care products to better focus on specialty pharmaceuticals it can develop in-house is curious. Other drugmakers are using acquisitions to bolster their patent losses.

Pfizer spun off its animal-health business last year and sold its infant-nutrition business the year before in a bid to clear the decks for its $106 billion takeover bid of AstraZeneca. Bristol-Myers Squibb became a pure-play drug company announcing it recently bought iPierian for up to $725 million. It bought Amylin Pharmaceuticals in 2012.

For Bayer, the acquisition means getting a portfolio of top products beyond just Claritin, including Afrin, Coppertone, and Dr. Scholl's, and adding them to its own stable of consumer care products like Aleve, Alka-Seltzer, and One-A-Day vitamins to make it one of the leaders in OTC products in North and Latin America. With both Novartis and GlaxoSmithKline agreeing last month to an asset swap worth $46.5 billion to create a combined consumer health-care business housing well-known brands such as Aquafresh, Sensodyne, and Panadol, the acquisition for Bayer will enable it to more effectively compete against them.

Bayer hopes to extract some $200 million in annual cost savings from the deal by 2017, and because the OTC market isn't affected by patent cliffs, it's a highly desirable space to enter, one that depending on the market is growing by double digit percentages, particularly in emerging markets. Latin America is expected to grow at 15% annually for the next five years and Bayer itself has experienced double digit growth in China. 

Yet Bayer will also collaborate with Merck on developing soluble guanylate cyclase modulators, or sGC compounds, for the treatment of heart failure and pulmonary hypertension. Merck has some early stage sGC compounds that it will make available to Bayer, which currently has vericiguat (BAY102) in phase 2 clinical development along with its own early stage sGC compounds. For those projects, Merck will pay Bayer $1 billion up front and milestone payments down the road upon achieving agreed-upon sales goals.

That type of investigational research is what drove Merck to shed the consumer health unit in the first place. It was a small contributor to its overall revenues and it had only about 1% of the market meaning it would have required a substantial investment to bulk it up. Instead of diverting money away from its core new drugs research for a division that had little chance of making a big impact, Merck can now use the money to bolster that research.

Merck is collaborating with other pharmaceuticals and biotechs like Pfizer and Amgen to evaluate novel combinations of anti-cancer regimens using its investigational anti-PD-1 immunotherapy MK-3475. So while it's largely going it alone, it's not completely eschewing relying on partners to help it forge ahead.

By slimming down to focus on human medicines,Merck gets a big influx of cash that it can use immediately to boost earnings and bolster its stock, which prior to the decision to seek strategic alternatives, lagged behind the performance of most of its rivals, rivals who also shed businesses to narrow their focus.

But breaking up the business is new and can be seen as something of a change in strategy since only two years ago, Merck's CEO said he had no intentions of doing so, viewing the calving off of operations as something of a "fad." The biggest risk perhaps is that it's giving up important cash flow at a time when its core drug business is in a bit of a tumult, so keeping them on track will be key to whether investors ultimately realize the benefits from the unit's sale. 

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