Merck's Future (Rule Maker) May 24, 1999

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Merck's Future

By Phil Weiss (TMF Grape)

TOWACO, NJ (May 24, 1999) -- This week, we're taking a look at some of the top pharmaceutical companies. Tonight, I'll be checking in on the industry's market cap giant -- Merck (NYSE: MRK). Over the past five years, the company has soundly crushed the market with a 40% compound average annual return versus 24% for the S&P 500.

The drug giant has a vast number of agents for a full-range of medical conditions. Here's a summary of the company's offerings:

Drug       Medical Condition
Zocor      high cholesterol
Mevacor    high cholesterol
Vasotec    hypertension/heart failure
Cozaar     hypertension/heart failure
Prinivil   hypertension/heart failure
Pepcid     stomach ulcers
Fasomax    osteoporosis
Crixivan   AIDS
Singulair  asthma
Maxalt     migraines
Propecia   male pattern hair loss
Vioxx      arthritis

If you check this table in Merck's 10-K, you can see sales by product line over each of the last three years. The top two product lines are drugs used to treat elevated cholesterol and those used to treat hypertension/heart failure. Over the last three years, these two product lines have accounted for sales of more than $25 billion. Merck also has a sizable pharmaceutical benefits management (PBM) business -- Merck-Medco.

Merck's best-selling product, Zocor, lowers LDL ("bad") cholesterol. In this same class, Merck actually has another product, Mevacor, but its patent has only two more years until expiration. According to Merck's first quarter earnings press release, Zocor is the world's second-leading medicine in terms of sales. Much has been made of Lipitor, another cholesterol-lowering drug that was developed by Warner-Lambert (NYSE: WLA) and marketed by Pfizer. As of April 15, Lipitor was receiving approximately 45% of new U.S. prescriptions among cholesterol-lowering agents. Even so, from 1997 to 1998, Zocor sales grew by 10% to $4 billion. With the "graying" of America, the overall size of the market for many of these products is expanding, allowing for more than one winner in a single category of drugs.

Merck's second best-selling drug, Vasotec, treats heart failure and high blood pressure. This drug accounted for sales of $2.4 billion in 1998, which was a 4% decline from 1997. Here again, U.S. patent protection is about to expire, with less than a year remaining. As a result, it is only being promoted as a heart failure treatment at this time.

Pepcid is next on Merck's list of top-selling drugs. 1998 sales were $1.1 billion, a 6% decline from 1997. But time is running out on this blockbuster as well, as the anti-ulcerant will lose U.S. patent protection in the fourth quarter of the year 2000. To some extent, the decline in sales is intentional, as it is customary for Merck to cut down on promotional expense as drugs approach patent expiration. At this point, Merck is simply milking Pepcid for maximum profitability before the onslaught of generic competition.

Merck's newer hypertension and heart failure drug Cozaar and its companion agent Hyzaar are among the company's fastest growing products. 1998 sales of these two drugs were $1.1 billion -- a 56% increase from 1997. Launched in 1995, this hypertension drug combo reached $1 billion of sales faster than any drug in Merck's history.

Fosamax is Merck's drug to treat and prevent postmenopausal osteoporosis and reduce the risk of fractures related to osteoporosis. 1998 sales were up by 46% over 1997 and totaled $775 million.

Another antihypertensive drug, Prinivil, had 1998 sales of $690 million. The patent for this drug also expires in 2001. 1998 sales of Crixivan, a protease inhibitor for the treatment of AIDS, were $675 million. Sales of these drugs increased by 18% and 16% respectively over the prior year.

One thing that I noticed in doing some additional research for tonight's report is that Merck discloses a lot less information in public documents than does our pfine pfilly Pfizer (NYSE: PFE). I looked through the 10-K and 10-Q, and I couldn't find any data listing sales figures for Merck's top selling products. So, I decided to place a call to the company to see what I could find out. I spoke with Sharyn Bearse of Public Affairs as well as Investor Relations.

I didn't discuss product by product sales for the first quarter of this year, but I did look at the product line data in this table from the 10-Q for the first quarter. Two things jumped out at me as being significant when I looked at this table. The first was that the Merck-Medco pharmacy benefit management business accounted for a significant portion of Merck's growth. Sales in this lower margin business grew by close to 35% year over year. Without these sales, Merck's revenues grew by only 16% rather than 24%. However, 16% growth is still a lot better than I think many would have expected to see with all the concerns among the Wise about Merck's current and future growth.

In the pharmaceutical industry, a product that has annual sales of $1 billion or more is considered to be a blockbuster. Currently, Merck has four such products, however two of them will be off patent within the next 18 months. So, let's see what there is to carry Merck's future growth.

The first thing that I like to try and understand is what products will most likely be the company's top sellers five years from now. Zocor's patent doesn't expire until December 2005, so it seems likely that one would be on the list. Cozaar has patent protection until August 2009, and Fosamax until August 2007. It seems fairly safe to assume that all three of these will be blockbuster drugs in five years from now.

Merck has had a number of new products receive Food and Drug Administration (FDA) approval over the last few years. According to the company sales of all of these products have met expectations so far. Singulair is already a leader in its class. By February of this year, 1.1 million prescriptions had already been written for this product. Maxalt is the fastest growing oral migraine medication in the U.S. This is an impressive feat given that it's the fourth product entrant into this category. As of December, over 1.1 million prescriptions had been written for Propecia, Merck's product for male pattern hair loss. All of these drugs seem to have various levels of promise, but at this point nothing that I've read convinces me that they will become blockbusters.

Finally, there is still one big ace in the hole. On Friday, Merck received FDA approval for its COX-2 painkiller Vioxx. This is the second such product on the market as Monsanto's Celebrex was approved earlier this year. I talked to the company about the differences between these two products. Celebrex has only been approved for osteoarthritis (OA) and rheumatoid arthritis (RA). In addition to being approved for OA, Vioxx can also be prescribed for acute pain and menstrual pain. RA studies are still on-going.

The final topic that we discussed was the lifeblood of any pharmaceutical company -- Merck's product pipeline. The company would not comment on the potential of any of its products currently in the research pipeline. But the drugs that are closest to market are those that are currently undergoing Phase III testing. This is the last phase before data is collected and a New Drug Application is filed. Phase III takes 2-4 years and includes clinical studies of patient populations in thousands of people. Merck currently has three products in Phase III.

Phase IIb testing lasts 9-12 months. It consists of large multi-center studies with a testing population in the hundreds. During this time, dose range and efficacy are studied. Merck currently has three products of note in this phase. Phase IIa lasts from 5-12 months and involves studies with a small number of patients that have the disease being tested. Merck currently has three products in this stage. Phase I usually lasts one year and involves clinical studies in health volunteers. Merck's most significant product in this phase is a cancer compound. For more on Merck's pipeline you might want to check this link.

All in all, I'm left feeling that Merck will continue to be successful. Sharyn Bearse, a 32-year veteran of Merck, said at the conclusion of our conversation, "Merck has always done well even during challenging times." The company also has an excellent record of bringing products through the research and development process and into the marketplace. However, this Foolish long-term shareholder is left thinking that owning this stock over the next five years may not be as rosy as it has been owning it for the last five.

If you have any questions or would like to continue the discussion further, please do so in either our Rule Maker Companies board or the Merck message board.

Phil Weiss, Fool

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