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July 23, 1998

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Subject: 9 reasons not to buy Merck
Author: URGataChow

Merck took a tumble yesterday, plunging nearly 10 points after reporting its earnings prior to the opening on Wall Street. What most investors may attribute to the fall as Merck missing the Street by a penny, there is much more to this story behind closed doors. Many of these investors may be blindly buying this stock when, in fact, it may actually be in more trouble for the near term. In the confrontation of the bulls and the bears for Merck, I have unanimously decided to side with the bears, for the short term anyways. I've included a list of 9 reasons why NOT to buy this stock now, as I see more troubles ahead for this currently puzzling pharmaceutical giant.

Reason #1: Lets start with the evident. Merck missed estimates by a penny. The company said second-quarter diluted per share earnings were up 15 percent, to $1.07. The consensus earnings estimate of analysts polled by First Call had been $1.08 per share. How many more quarters of .01 disappointments from Merck can the Street take anymore? They reward this stock by taking it soaring with the rest of the industry, but doesn't get much in return the past two quarters. However, drug companies at times disappoint, so this may not be a reason at all...just a statement, unless this continues.

Reason #2: The company guided estimates downward for the remainder of this fiscal year. Estimates had ranged from $4.27 - $4.39. Merck feels comfortable in the lower end of that range.

Reason #3: Most everybody already knows that Warner Lambert's Lipitor is killing Zocor and Mevacor on the marketplace, Merck's two lead anti-cholesterol drugs. Lipitor now owns a commanding 32.9% US market share which puts Merck's 40% stake (Zocor and Mevacor combined) at high risk in the future. Zocor's US market share has been heavily reduced to now 24.4%. Recall that Lipitor is still a brand new drug; however, it has already conquered the US market and has snatched the title as #1 cholesterol lowering agent in the US from Zocor. Lipitor still faces numerous other launches in the near future, and is also the only drug in its class approved for types III and IV lipid disorders. Although Zocor sales were up 12% this quarter to $965 million, sales of Mevacor continued a rapid decline, down another 33 percent to $190 million from a year earlier. In the first quarter, Zocor had $875 million in sales, down from $1 billion in the fourth quarter 1997. Lipitor sales more than tripled this quarter to $533 million for Warner in its second full year on the market. In short, there is more damage to be done to Zocor and Mevacor's highly at risk market share.

Reason #4: Vioxx is becoming a concern surrounding Merck. Vioxx, the company's COX-2 inhibitor for inflammatory disorders, was supposedly the biggest thing Merck had in its short term pipeline. This drug was given the task to help off-set the patent expiration of Vasotec when it came stampeding in. In clinical trials, the drug was running neck and neck with Monsanto's and AHP's Celebra although at times it did seem transparent that Celebra had the head lead, and on earnings day, Merck confirmed that. Merck has said that it plans to file for Vioxx with the FDA in December. That is a big setback, as Monsanto and AHP (with their marketing partner, Pfizer) are planning to file for Celebra this summer. This gives Celebra a BIG head start over Vioxx, as it most likely will be granted fast track status by the FDA. Initially, Celebra is already 4-5 months ahead of Vioxx, and with a fast track status, Celebra should leave Merck in the dust with a commanding 10-11 month head start on the market place. While Celebra is out conquering the market place, Vioxx will be busy under FDA panel review. I didn't like this at all, and should persuade some analysts to lower their sales expectations on the drug. While Monsanto and AHP management are opening a bottle of champagne for their amazing rate of clinical advancement, Merck is busy biting its nails over how its going to recover from lost time.

Reason #5: Patent expirations are perhaps the biggest concern surrounding this company. Vasotec, Prinivil, and Pepcid are the first three BIG products to get the heave ho in 2000 and soon after. And these are some pretty BIG products losing patent protection. Merck will feel the wrath of the patent hell-hole that Pharmacia & Upjohn was thrown into the past several years while the entire industry glided forward. Vasotec was the 10th largest drug on the US market last year (doing sales of over $900 million in the country); however, world-wide sales of the ACE inhibitor exceeded $2.5 billion, Merck's second biggest drug behind Zocor. Pepcid achieved 1997 sales of $1.18 billion, yet another billion dollar drug. All investors have my word on this, Merck will not get through the next few years without feeling the sting of patent losses. Merck's scheduled patent losses in the coming 5 years are above the industry standard, and more importantly, Merck is losing these patents on key flagship drugs.

Reason #6: Poor sales of Propecia. Anybody have any idea how much money Merck committed to this wanna-be drug? A lot. Sales of this has-been (actually make that a never-was) totaled $16 million in its second quarter on the market (in its first quarter it achieved sales of $13 million). Almost no growth in this product. If I was part of Merck senior management, I'd take all the Propecia marketing dollars and commit it to a better drug, like Fosamax, which was one of Merck's bright spots this quarter. Sales rose 30 percent to $165 million for the osteoporosis treatment. Don't forget that, if any drug has been a huge disappointment, Propecia fits the shoe. Some analysts had first full year sales expectations of $400+ million! The way its doing now, its on track to do $60-$70 million in sales in its first full year.

Reason #7: Disappointing sales of Aggrastat (this one is purely my opinion). Although it was the drug's first quarter on the market, it did sales of only a meager $6 million. I'll give this drug some time, and hopefully it'll emerge as one of the company's future leaders. Several drug analysts say that Aggrastat may become a $500 million drug someday down the road, but so far, it looks not likely. To give you an idea of how disappointing three of Merck's newest drugs have been as of lately (Propecia, Aggrastat, Singulair), I give you this analyst comment: ABN-AMRO drug analyst James Keeney said that three new Merck prescription drugs generated combined revenues of $60 million in the second quarter, which was 35 percent below his forecast of $92 million. Cosopt (hyped up by Merck to be a great alternative treatment for glaucoma) also performed very poorly. These three drugs are critical to Merck's future. Although they may not do much in terms of individual revenues, combined, they must offset some of the patent expiration blows Merck will endure. So far, they aren't living up to expectations.

Reason #8: New AIDS therapies coming out in the near future. Merck owns Crixivan, currently the #1 HIV protease inhibitor. 1997 sales of this drug totaled $530+ million, so if something negative was abound, this stock isn't for the faint-hearted. Dupont Pharmaceutical owns Sustiva, a non-nucleoside reverse transcriptase inhibitor (NNRTI). NNRTIs are a rather scarce class of anti-HIV drugs. Currently, there are only two of these on the market: Roche's Virammune, and Pharmacia & Upjohn's Rescriptor. After the AIDS conference in Geneva, Sustiva was being touted as the biggest AIDS drug yet to hit the market. Its potential use to dramatically lower the number of pills one has to intake daily, along with its excellent safety profile, had many analysts questioning whether or not there was any need for the protease inhibitor in the market. Not only did this affect Merck, but two rivals as well, Agouron Pharmaceuticals and Vertex Pharmaceuticals. Agouron has a protease inhibitor on the marketplace, Viracept, and Vertex had one pending approval with its licensee, Glaxo Wellcome. This was a false assumption though that the protease inhibitor would no longer have use. These class of drugs are currently the most powerful HIV weapons to date. So, maybe Sustiva raised a false scare, but there are still more Crixivan concerns. Agouron's Viracept, a newer PI, is rapidly stealing market share from Crixivan, literally eating Merck's lunch. Viracept has a better safety profile, is much more effective, and overall has a much more favorable profile. Very very soon, within the next few weeks or so, the newer Viracept will overtake Crixivan as the #1 protease inhibitor on the marketplace. Yet still, there are more concerns. Recently, protease inhibitors, as a class, have been associated with causing oddities in the patient. Such reported side effects included fat pads around the neck line and stomach areas, and eventually in the long run PIs have been linked to causing diabetes and obesity among other side effects. This study more or less correlates with Crixivan rather than Viracept whose side effects are much more minimal. Crixivan is on the verge of tripping itself and falling and I'll be watching these developments in the HIV arena very closely in the coming months.

Reason #9: Merck has a weak late stage pipeline. This company is on track to achieve over $2 billion in R&D spending (neck to neck with Pfizer for the lead in the industry), but I have yet to see any real results from it. Although they have won approval for 5 drugs since December of 97 (Proscar, Singulair, Propecia, Aggrastat, and Maxalt), NONE have yet to show any real results besides the asthma chewable tablet, Singulair which achieved sales of $38 million on its 2nd quarter on the US market. Maxalt seems pretty exciting though, and it has yet to show any results because it was just launched so that one needs some time. Still, I don't see too many exciting potential products in Merck's late stage (Phase II/III) pipeline besides Vioxx, which recently suffered a setback with the announcement on earnings day. MK-991 is a potent antifungal agent in Phase II and MK-826 is an antibiotic in late Phase II clinical trials. These two seem to have the best potential in Merck's late stage pipeline outside of Vioxx.

Despite all these negatives, this company has done a few things right as of late. Selling their stake in Astra Merck and Dupont Merck, was a fantastic strategic move by the management IMO, giving Merck a huge pile of cash which it is still sitting on. Most of this may end up going back into the pipeline, but I feel its essential that they make a product acquisition or two, maybe even acquire another company to broaden their weak late stage pipeline. Yet still, amid all these patent concerns several products continue strong growth. Fosamax, Cozaar, and Hyzaar among others. In the long term this company is in great shape, but in the coming years they will encounter multiple challenges, some they will overtake, others which will overtake them. However, this is all just one bump in the long road ahead. I think I'll wait for the impact to strike, sit patiently anticipating some aftershock, then I will invest my money into this pharmaceutical leader, because in truth, it is a great company.


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