Merck Likes FoxHollow

One of the best signals that a small-cap drug or medical device company holds promising technology is the presence of one of the established pharmaceutical companies as a partner. FoxHollowTechnologies (NASDAQ:FOXH), maker of a device to remove plaque in the legs that can block arteries, achieved this goal in September of last year when it signed on pharmaceutical giant Merck (NYSE:MRK) as a research partner.

Perhaps as an anniversary present, Merck signed another collaborative research agreement with FoxHollow earlier in the week that will expand the scope of the company's current research and give Merck a stake in FoxHollow.

The deal calls for Merck to pay FoxHollow $40 million over a four-year period in exchange for FoxHollow collaborating exclusively with Merck on its research in certain diseases. In addition, Merck will pay $60 million to FoxHollow for doing this research, as well as acquire $95 million worth of newly issued shares of FoxHollow.

In just two days, Merck has already reaped some nice rewards from this deal. Merck is acquiring the $95 million worth of FoxHollow shares at a sales price of $29.63 a share. Merck's equity stake represents nearly 11% of outstanding FoxHollow shares. With shares of FoxHollow opening today at $34.14, this represents more than 15% appreciation on these shares for Merck (that's a 2,700% annualized return thus far).

FoxHollow is not exactly a behemoth of a company in terms of market capitalization. The company is valued at roughly $860 million, and with all the investment Merck has been doing with FoxHollow, it begs the question: Why doesn't Merck just acquire all of FoxHollow? There are probably several reasons for this, but the most likely answer is that medical devices are outside the scope of Merck's main focus.

That being said, I would not be surprised to see Merck acquire FoxHollow sometime in the future -- and I'm not the only Fool analyst thinking FoxHollow might be sold off someday, either. Regardless of whether FoxHollow remains a stand-alone company in the future, this deal with Merck is a great affirmation of the strength of the company's technology and research. For a medical device company, nothing is more important than that.

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Fool contributor Brian Lawler does not own shares of any company mentioned in this article. The Fool has a disclosure policy.