Will Merck's Bold Hepatitis C Play Pay Off?

There is a significant (and sometimes larger than expected) gap between "looks like it can compete" and actually competing with a rival that has both strong data and a big head start, but Merck (NYSE: MRK  ) continues to show that it is serious about competing with Gilead (NASDAQ: GILD  ) and AbbVie (NYSE: ABBV  ) in the market for advanced therapies for hepatitis C (or HCV). The company's nearly $4 billion acquisition of Idenix (NASDAQ: IDIX  ) is an expensive affirmation of that long-term focus, but one that could start paying off before the end of the decade.

The deal
Merck took the Street flat-footed Monday morning when it announced that it had reached an agreement with Idenix to acquire the HCV-focused biotech for $24.50 per share in cash, or a total deal value of $3.85 billion (about 2% of Merck's enterprise value).

As Idenix had closed Friday at a price of $7.23 and had an average sell-side price target of $7.67, it may be defensible to say that this was not the consensus expected outcome. On the other hand, the shares had been climbing through the month of May and there were rumors that Johnson & Johnson (NYSE: JNJ  ) and AbbVie both had interest in Idenix. A nearly 240% premium to the recent price would certainly seem to support the idea that Idenix negotiated from a position of strength.

The rationale is in the long term
Idenix is not a deal that is going to help Merck today. The company's strongest pipeline asset, the nucleotide prodrug IDX21437 (or '437) is a Phase II asset (it has successfully completed a Phase I study) and it is not likely that Merck will get it to market (in the form of a combo therapy) before 2017.

It could be well worth the wait for Merck. A small Phase I study showed efficacy that was lower than Gilead's Sovaldi (a 4.2 to 4.3 log drop versus 4.5), but close enough to be competitive. By no means do these data "prove" that '437 can anchor a combo regimen, but it does at least raise the potential that Merck can combine it with '5172 and '8742 into a fast-acting and highly effective one-pill/once-daily combo.

As a reminder, Merck reported data back in April that indicated that the combination of '5172 (an NS3/4A protease inhibitor) and '8742 (an NS5A) was highly effective in chronic HCV genotype 1 patients. These data were stronger than the Street had been expecting and raised hopes that Merck would be a competitive third entrant in the advanced HCV combo market behind Gilead and AbbVie.

Merck is already under way with the C-SWIFT study that adds Gilead's Sovaldi to that combo, and data from the trial could offer a read-through on the combo potential of '437 (though it is very important to be clear that '437 and Sovaldi are not identical). With '437 in hand, Merck will almost certainly move into clinical studies as a triple therapy, with the goal of an ultra-fast (four to six-week) regimen hitting the market in 2017.

Importantly, Merck will get much better economics on a wholly owned triple therapy. Merck will owe royalties to Novartis for Idenix products that range from the high single-digits to low teens, but that's far better than having to pay the cost of including Solvadi.

Plenty can still go wrong
By no means is it a certainty that Merck now has a great triple combo on the way. There haven't been any safety flags so far with '437, but investors certainly remember how the $2.5 billion deal between Bristol-Myers and Inhibitex blew up in Bristol-Myers' face when safety issues killed the prospects for the lead drug. While the Inhibitex nuc was a guanosine analog ('437 is a uridine analog) and there were preclinical signals of potential problems, the fact remains that safety (or efficacy) issues could still appear along the way; that virology drug trials are more consistent between Phase I, II, and III than oncology drug trials doesn't mean there are no surprises. Along similar lines, Idenix has had its share of clinical failures along the way.

It's also important to note that Gilead has established a very high bar. I never expected Gilead to hold 100% of the HCV market indefinitely (and I don't believe any serious analyst or investor thought so either), but Gilead will have the advantage of significant time-to-market leads and gaining share in the absence of superior data will be challenging. The good news, from Merck's perspective, is that the HCV market is not going away and a second- or third-place position in multibillion dollar global market is well worth the trouble.

The bottom line
Given the premium Merck agreed to pay, and the strategic value of inserting '437 into its existing experimental combo therapy, I don't see a high likelihood of rival bidders. Instead, attention may shift to Achillion Pharmaceuticals as the "last man standing" in the field of potential HCV acquisition targets.

For Merck, this is a deal about the future. Yes, nearly $4 billion is a lot to pay, but even with the strong portfolios at Gilead and AbbVie, there is likely to be enough to go around in the HCV market for this deal to pay for itself over the long term.

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