Merck Joins the Low-Margin Party

Welcome to the party, Merck (NYSE: MRK). I'm not exactly sure low-margin sales are your thing, but since all your comrades are here, I'm not surprised you joined the party.

The American drugmaker announced yesterday that it was partnering with Sun Pharma to establish a joint venture to sell branded generics in emerging markets.

Merck joins a growing list of drugmakers that have partnered with Indian pharmaceutical companies.

Abbott Labs (NYSE: ABT) went the acquisition route with an outright purchase of Piramal's Healthcare Solutions.

There's no doubt these deals will grow revenue. The citizens of emerging market countries such as India and China are demanding more and more medications. Set up shop, put a placard out front, and the rupee and yuan will come pouring in.

But how much profit can be made is an entirely different story. Drugmakers can't command the high prices they can get stateside. Last month, China slashed prices on drugs by an average of 21%. Low margin is the name of the game.

The companies may be able to make up in volume what they lose in net margins, but will the total profit be enough to justify the investment? It's not like there aren't other uses for pharma's capital. Would licensing a potential blockbuster result in more profits than branching out globally?

The pharma giants clearly don't think so, but I'm not sure investors should be drinking the Kool-Aid at the party. At the very least, don't be fooled by the revenue numbers that are sure to increase over the next couple of years. Keep an eye on the free cash flow to see if this party is a bust or not.

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