Earlier this week, after covering Merck's (NYSE: MRK) pharmacy benefit management (PBM) unit in my August 16 Rule Maker column, Merck-Medco made news when the company announced 80% of its members who receive Prozac through home delivery had been switched to a generic substitute in the past week. The press release went further, noting that if the trend continues, its plan and sponsors should save more than $40 million over the next six months.
The news is an example of the cost savings PBMs like Merck-Medco provide, but it also shows how quickly generics steal market share from brand-name drugs. According to a recent article in The Wall Street Journal, generic drugs typically acquire half the market from branded drugs within six months of a patent expiration. For Merck, a company that owns the largest PBM in the country and has several drugs facing patent expiration, the statistic is a classic double-edged sword.
Despite the revenue opportunities in the PBM industry, Merck is struggling as it faces key patent expirations and a pipeline Wall Street has called weak. As I argued in our introduction of the company, however, the company sports positives that seem to have been lost in Wall Street's skepticism. Most notably, Merck's top five drugs continue to post strong sales and its history of innovation leaves us confident in its ability to develop new drugs. Having said that, let's quickly look at its key drugs and pipeline.
In 2001, Merck's five top-selling drugs -- Vioxx (pain), Singulair (asthma), Fosamax (osteoporosis), Zocor (cholesterol), and Cozaar/Hyzaar (hypertension) -- grew revenues 54% over the previous year to $11.1 billion and represented 47% of pharmaceutical sales. Last quarter, while that growth dropped to 27% over the year-ago period, Merck's five fastest-growing drugs managed to chip in revenues of more than $3.5 billion and made up 60% of the company's total pharmaceutical sales.
Zocor, Merck's top-selling drug that treats high cholesterol, grew revenues 19% to nearly $5.3 billion in 2000. Pfizer's (NYSE: PFE) Lipitor has really had its way with Zocor and other cholesterol drugs, but Merck has started on a joint development effort with Schering-Plough (NYSE: SGP), a company that some investors have speculated might be a potential acquisition target for Merck. The partnership involves combining Zocor with Schering's cholesterol absorption inhibitor that's currently in Phase III trials. Notably, Pfizer is working on a similar arrangement.
Merck's arthritis drug Vioxx, also known as a COX-2 inhibitor, grew revenues nearly 600% to $2.2 billion in 2000. While Vioxx faces stiff competition from Pfizer and Pharmacia's (NYSE: PHA) Celebrex, both drugs should keep posting strong sales, given that clinical trials show COX-2 inhibitors perform as well as anti-inflammatory drugs in blocking an enzyme that causes the inflammation. The potential for broader use of COX-2 inhibitors, such as cancer prevention, also exists, as does increased competition from AstraZeneca's (NYSE: AZN) forthcoming cholesterol drug.
Cozaar/Hyzaar, which grew sales 25% last year to $1.5 billion, is the leading hypertension drug, but Novartis' (NYSE: NVS) Diovan has caught up in total prescriptions written. In a Barron's Online interview, when asked what Merck was doing to promote the franchise, CEO Raymond Gilmartin said, "A study with Cozaar showed that there was a significant reduction in end-stage renal disease in diabetics." Still, despite the advantage of reducing kidney problems in diabetic patients, sales are slowing as Diovan continues chipping into the drug's market share.
Excluding Singulair, Merck's Fosamax, which grew sales 25% last year to $1.3 billion, is the company's most significant growth driver as the number of people seeking treatment for osteoporosis has nearly doubled over the past year. The drug faces competition from several other offerings, most notably Eli Lilly's (NYSE: LLY) Evista, but Fosamax has an advantage in that it can be taken once a week, compared to other products that must be taken every day. Procter & Gamble (NYSE: PG) is also working on a similar offering that's expected in late 2002.
Singulair grew sales 107% in 2001 to $860 million, but the opportunity is forthcoming as Merck strives for broader usage of the asthma drug. Roughly 15 million Americans battle Asthma, but prevention rather than treatment has grown increasingly popular with the help of drugs like Singulair. Merck's also going after the seasonal allergic rhinitis (SRA) market where drugs like Claritin have racked up sales. If Singulair as a standalone doesn't address this market, Merck plans to use the drug in combination with Claritin, another example of the Merck and Schering-Plough partnership.
The significance of Vioxx, Singulair, Fosamax, Zocor, and Cozaar/Hyzaar is that when Merck's patent expiration exposure ends by the middle of next year, these five top-selling drugs will still have sizeable market potential remaining. Still, pharmaceutical companies are judged on new drugs and pipeline and Merck's -- 12 products in stage II and III trials according to Barron's Online -- could make up for at least some of the lost sales from drugs like Prilosec (ulcers) and Prinivil (hypertension).
As for new and future drugs, Merck just released Candidas (anti-fungal) and should launch an antibiotic called Invanz later this year, although sales will be far from the industry's blockbuster billion-dollar status. Before the end of the year, it should also file for its second COX-2 inhibitor, Etroicoxib, an improvement over current successes Vioxx and Celebrex that has blockbuster potential. Merck also has a Substance P (depression) in late-stage trials and a cholesterol-lowering drug ezetimibe via a partnership with Schering, both of which have solid potential.
Clearly, we need to take a closer look at the company's pipeline and the possibility of broader usage of some of its key drugs, which is critical given its patent expiration exposure. Next week, we'll take a closer look at Merck's research efforts, management team, and most importantly, valuation. Merck currently trades at 20.1 times next year's earnings, a discount to both the S&P 500 and drug industry, which trade at multiples of 20.4 times and 23.7 times, respectively. Still, our final analysis must include what we think is a reasonable price to pay for the company.