Merck Just Made a Big Move -- but Will It Be Enough for Investors Right Now?

Big pharmas have the resources to make big, multi-year moves that can reshape or even redefine their businesses. As you may know, Merck (MRK -0.13%) is one of the largest of the big pharmas, with a market capitalization of $262 billion, and it just made one of those moves.

Now, with a gloomy market environment and generic competition to its most profitable drug looming on the horizon, Merck may well need such a move to wow the market. Let's learn about what the company committed to doing recently, and whether it can help move the needle and drive its stock upward.

What's the move and what will it do?

On Oct. 19, Merck announced that it will be teaming up with the Japanese drug developer Daiichi Sankyo (DSNKY 2.53%) to try to commercialize three of Daiichi's clinical-stage antibody-drug conjugate (ADC) candidates, intended for use in treating solid tumors across a few different cancers. Merck will pay $4 billion up front, and it could eventually be on the hook for as much as $22 billion in total costs when including the agreed-upon milestone payments. Daiichi will retain the rights to commercialize all three programs in Japan, assuming that the clinical data look good to regulators.

Merck management thinks that by the mid-2030s, the trio could yield billions of dollars annually in revenue for each partner. That's good news for Merck shareholders as it means the company's leadership is busy planting the seeds for its future success. But why forge such a large and long-term deal right now? In short, because one of its most critical cash cows will soon start to fade.

Keytruda is Merck's star oncology biologic, capable of treating a bevy of different cancers. Those include non-small cell lung cancer (NSCLC), Hodgkin lymphoma, colorectal cancer, squamous cell carcinoma, and many others. It's also currently being investigated to treat mesothelioma, ovarian cancer, and prostate cancer, just to name some of the myriad ongoing clinical trials seeking to expand its indications even further. In the third quarter alone, Keytruda was responsible for more than $6 billion in revenue out of the company's total haul of $16 billion.

Importantly, Keytruda's patent cliff is coming up in 2028, after which its market share will doubtlessly be devoured by generic copies. That means developing or procuring medicines which can replace its share of sales is a priority. And the replacements are going to have some big shoes to fill since Keytruda probably isn't even near its peak revenue yet.

It'll take a while for the deal to pay off

In considering the potential impact of the newly announced partnership and its ability to replace Keytruda, there are a couple of reasons why investors may be somewhat skeptical.

The three programs Merck is collaborating on with Daiichi Sankyo are in early- to mid-stage clinical trials. The probability of an investigational oncology medicine surviving the journey from the start of its phase 1 trials all the way to regulatory approval and commercialization is around 3.4%. Therefore it's entirely possible, and sadly quite probable, that all three candidates will fail to prove their safety and efficacy for at least a few of the cancers they'll be investigated to treat.

The two companies will simply take a shotgun approach to matching these ADCs to the disease contexts where they'll do the most good, and the process won't be easy. Investors should absolutely count on numerous setbacks over the coming years, some of which will doubtlessly dent the share price.

But if Merck is keen to research and then squeeze every single drop of possible utility out of these three programs, as it's doing with Keytruda, a total wipeout by all three is very unlikely in the long run. Much as with Keytruda, it already has a few plausible avenues for testing at least one of the new candidates in conjunction with other oncology medicines, which have different mechanisms of action, to see if there are any synergistic effects. So a failure to demonstrate efficacy as a monotherapy isn't the end of the line by any means.

Nor does a success as a monotherapy in a given niche rule out an approval for use as an add-on treatment. In the same vein, if the programs demonstrate to regulators that they're effective as second- or third-line treatments (or even treatments of last resort), the more lucrative indications for first-line use could be secured afterward.

In sum, the addressable market for each therapy could keep growing for years and years. With so many different opportunities for the trio of medicines to get their feet in the door and start generating revenue by the middle of the next decade, management's hypothesis about their peak revenue potential looks reasonable. But it's going to take a while for Merck to realize that possibility; the research and development (R&D) process will be ongoing for at least a few years.

Nonetheless, this move is a big contributor to the bull thesis for buying this stock. Just make sure you're willing to actually hold Merck shares for as long as it'll take for the company to extract some value and recoup the cost of its investment.