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Merck & Co.'s Patent Cliff In 2017

By Todd Campbell – Oct 27, 2016 at 9:01AM

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The expiration of patents on some of the company's top-selling drugs poses big headwinds for investors.

Image source: Getty Images.

Merck & Co(MRK -1.08%) is a global pharmaceuticals giant with tens of billions in annualized sales, however, the company's top line is about to take a hit in the coming year because of patent expiration on Remicade, Cubicin, and Zetia -- three of its best selling medicines.

Mounting patent headwinds

Through the first nine months of 2016, sales of Merck's top selling autoimmune disease drug, Remicade, have plummeted from $1.4 billion last year to less than $1 billion. The drop is due primarily to the launch of Remicade biosimilars in Europe, where Merck is licensed to sell the drug. Biosimilars are effective inexact copies of brand name medicines, and since they're usually priced at a 30% to 40% discount to the brand-name drug, doctors and patients tend to favor them.

Pfizer's Hospira launched the first Remicade biosimilar, Inflectra, in Europe last year, and Biogen and Samsung BioLogics launched another Remicade biosimilar, Flexabi, earlier this year. Because there are multiple Remicade biosimilars on the market now, Merck's Remicade revenue is likely to continue falling in 2017. 

Merck is also about to feel the pinch of patent expiration on Cubicin, a treatment for flesh-eating bacteria. After failing to block generic competitors from launching until 2020, U.S. patents on Cubicin expired this summer. Since that expiration puts roughly $1 billion of Merck's revenue in play, Merck's management is warning investors to expect "a significant decline in U.S. Cubicin sales going forward."

Patents protecting Merck's cholesterol-lowering therapy, Zetia, are also on the chopping block. Zetia patents expire in December and Merck anticipates a "significant decline in U.S. Zetia sales thereafter." Zetia's U.S. sales were $411 million last quarter.

Across all three drugs, competition due to patent losses will put nearly $4 billion of Merck's $42 billion in annualized third quarter sales at risk in 2017.

Image source: Getty Images.

Managing the risk

To offset patent headwinds, Merck is going to need its fast-growing drugs, including Gardasil 9, Keytruda, and Zepatier, to over-deliver.

Gardisal 9 is a vaccine that protects against human papillomavirus (HPV), and in Q3 combined Gardasil and Gardisal 9 sales totaled $860 million, up 38% year over year. Recently, a two-dose vaccination regimen for Gardasil 9 in certain girls and boys between ages 9 and 14 won FDA approval, and the U.S. Centers for Disease Control and Prevention's Advisory Committee on Immunization Practices voted to recommend that two-dose approach. Previously, Gardasil 9 was given via three-doses.

Because the FDA estimates Gardasil 9 "has the potential to prevent approximately 90 percent of cervical, vulvar, vaginal and anal cancers," and the dosing burden on patients is falling, Gardisal 9 is likely to remain a top-seller in 2017.

Keytruda, a PD-L1 inhibitor that stops cancer from over-expressing PD-L1 to avoid detection by the immune system, also offers support to sales in the coming year.

Initially, Keytruda was approved for use in melanoma patients in 2014, but Keytruda's label has expanded since then to include head and neck cancer patients and lung cancer patients, too. Because of those label expansions, Keytruda's sales climbed from $159 million in the third quarter of 2015 to $356 million in the third quarter of 2016.

Keytruda's sales could head even higher next year because it recently secured approval as an alternative to chemotherapy in newly diagnosed metastatic non-small cell lung cancer patients with high PD-L1 levels. This approval has led to industry watchers increasing their outlook for Keytruda's sales in 2017. For example, Bernstein's analysts bumped up their Keytruda sales outlook for next year by roughly $1 billion following the FDA approval. 

Zepatier, a hepatitis C drug, also offers the company top-line tailwinds heading into next year. Zepatier won FDA approval in January and aggressive pricing by management undercut competitors and resulted in first, second, and third quarter sales of $50 million, $112 million, and $164 million, respectively.

Eyes on 2017

Historically, patent expiration causes the vast majority of brand-name drug sales to shift to competitors, however, it's anyone's guess exactly how quickly that will happen at Merck.

Merck's fast-growing drugs provide it with some insulation, and if the company secures FDA approval of MK-1293, a biosimilar to the $6 billion plus per year insulin Lantus, then it may be in even better shape to handle the hit to sales caused by expiring patents. Nevertheless, since expiring patents could weigh down sales and profit next year and cause shares to trade lower, the company's patent risk can't be ignored by investors.

Todd Campbell has no position in any stocks mentioned. Todd owns E.B. Capital Markets, LLC. E.B. Capital's clients may have positions in the companies mentioned. Like this article? Follow him on Twitter where he goes by the handle @ebcapital to see more articles like this.

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