Following months of speculation over pharmaceutical giant Merck's (MRK -0.15%) potential takeover of cancer-focused biotech Seagen (SGEN), reports are now surfacing that the two companies couldn't reach an agreement over pricing. So now it seems that nothing may come of it after all. So does this change Merck's value?
Why Merck might be interested in Seagen
Merck has one of the premier oncology franchises in the industry and sells $17 billion of industry-leading cancer drug Keytruda. The drug is approved for at least 14 different types of cancer, and its sales just keep growing. Year-over-year revenue grew 26% in the second quarter. But Keytruda's patents expire in 2028, and Merck needs to find a way to replace a drug that currently accounts for about one-third of its total sales.
Meanwhile, Seagen offers sophisticated technology that directly targets a tumor to improve cancer treatment. The idea is that its antibody-drug conjugates (ADC) can differentiate between cancer and healthy cells, so the medicine only acts where it is needed. The construct contains a monoclonal antibody to identify and bind to the cancer cell, triggering a process to release the chemotherapy inside the cancer cell. This should make the treatment more effective while limiting the side effects.
The company also owns proprietary sugar-engineered antibody (SEA) technology, basically growing the antibody-producing cells in a sugar solution that helps the antibodies bind more tightly to their target. The company believes this stimulates a stronger immune response and may allow the immune system to destroy a tumor directly.
ADC technology has great potential but has delivered mixed results. Pfizer's leukemia ADC fizzled in the early 2000s, and both AbbVie's $5.8 billion purchase of Stemcentrx and Gilead Sciences' $21 billion acquisition of Immunomedics have gone nowhere.
Roche's Kadcyla and Polivy combined to generate $1.3 billion in the first half of 2022, but the company is skeptical about developing more ADCs. More promising, Daiichi Sankyo's and AstraZeneca's breast cancer drug Enhurtu has peak sales estimates of $10 billion. Overall, about a dozen ADCs have been approved to treat a variety of cancers.
It is a competitive area, as there are as many as 50 smaller biotechs developing their own unique twist on the basic technology, but Seagen has one of the deepest portfolios, with four approved drugs. The company also has a clinical pipeline of 12 more potential candidates. However, they are at a relatively early stage, as only three candidates are in phase 2 clinical trials and the remaining are still in phase 1.
The rumored deal
Rumors have been circulating ever since The Wall Street Journal reported on the potential merger earlier in the summer. But the companies themselves have remained silent, even after the late July verdict in Seagen's lawsuit against Daiichi Sankyo. Seagen claimed that the Japanese drugmaker's breast cancer drug Enhertu infringed one of its patents and was awarded $42 million in damages but missed out on future royalties of the potential $10 billion blockbuster. Some news suggested that Merck was struggling to put a valuation on Seagen, followed by last week's headlines that the talks had hit a snag over pricing.
Rumors had put the deal as high as $40 billion, or about $217 per Seagen share. This is more than a 40% markup on Seagen's beginning of the year $150 share price. Even after the recent drop in stock price following the stalled deal, Seagen is valued almost equivalently to Biogen, which generated $2.1 billion in net income over the past 12 months.
Seagen, however, is in the red. The company generated $1.8 billion in total revenue over the trailing 12 months. The company has launched three new treatments in the past several years, so these sales should grow. Analysts expect Seagen could bring in as much as $7 billion annually by 2028. But right now, it is expensive to produce these therapies, and substantial R&D expenses eat away what little profit is left. Seagen made a net loss of $740 million over the past 12 months.
The upshot
Merck doesn't necessarily need to own Seagen in order to benefit from its technology. In fact, the two companies already have several ongoing collaborations. The largest of these involves joint development of ladiratuzumab vedotin for breast cancer and other solid tumors. The companies have been working together since 2020 to look at the therapy by itself and in combination with Merck's Keytruda. This deal cost Merck a $1 billion equity investment, roughly 3% of Seagen's outstanding shares, along with a $600 million up-front payment and milestone payments. In exchange, Merck splits future profits 50-50.
Given the difficulty in valuing ADC technology and its inherent risk, a collaborative route may be safest for Merck. The company must fill its future revenue gap when Keytruda loses patent protection. However, Merck still has six years and $9.8 billion cash on the balance sheet to shop around. With its good valuation and generous 3.2% dividend, investors should hold tight.
