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Merck & Co. (MRK), the world's third largest drug maker by sales, is partnering with South Korean Samsung Bioepis, a joint venture that operates as a subsidiary of Samsung Biologics, to develop and market 'bio-similar' drugs that act as alternative to the much more expensive biologic drugs. The financial details of the deal weren't disclosed, but it was revealed that Samsung Bioepis will develop the drugs and would get all the necessary regulatory approvals, which will then be sold to Merck, who will be responsible for marketing activities.

Although 'bio-similars' are often referred to as generic versions of biologic drugs, they are nowhere near as low-priced as generics are compared to conventional drugs. The world's leading drug makers have been reporting declining sales in the last couple of years on losses of valuable patents, and are now facing tough competition from generics. Both Merck and its chief rival Pfizer (PFE) have seen year-over-year (YoY) revenue growth slow, if not outright fall significantly - this is especially true in the case of Pfizer, who lost revenue from the expiration of Lipitor's patent last year.

Merck also lost a major drug, Singulair, to generics, which was one of the primary drivers behind the decline in its fourth quarter earnings. The company's quarterly revenue fell by ~5% to $11.74 billion, driven by 67% drop in asthma drug Singulair sales from $1.46 billion in Q4-2011 to $480 million in Q4-2012. However, the 18% increase in sales of diabetes drug Januvia from $960 million to $1.13 billion made up for some of the Singulair losses. Within a span of one year, Singulair went from being the number one contributor to Merck's revenues to the fourth, and this doesn't include the loss of market exclusivity in developed regions of Europe, which happens in late February 2013.

The company's animal health unit, which competes with Pfizer's very successful spinoff Zoetis (ZTS), reported a 3% increase in revenues to $898 million. It was rumored that Merck might follow in Pfizer's footsteps with a new listed animal health arm, but the company's chief Ken Frazier has clearly stated that Merck has no such intentions.

Merck's net income for the quarter fell by 7.3% to $1.40 billion. Excluding extraordinary items, this translated into $0.83 per share. Revenues were $260 million more than Wall Street's expectations mainly due to strong performance from Januvia, Janumet (up 17%) and Gardasil (up 61%).

What's disappointing for investors is the series of operational setbacks that the company has faced. Its much hyped experimental osteoporosis treatment drug Odanacatib will go for regulatory approval in 2014 nearly a year late. Furthermore, medical trials for its cholesterol drug Tredaptive have failed and it has been removed from the company's pipeline. The drug is currently being sold in 40 countries, including some in Europe, and generates $13 million sales annually but the company will now scale back its operations. However, Merck will still achieve its objective start the approval process for five new drugs this year.

For the current fiscal year, Merck is expecting flat revenues (in constant currency terms) and expects adjusted earnings at the midpoint of $3.65 per share, which would be a 4.4% from its 2012 non-GAAP EPS of $3.82 per share. For the current quarter, it has reduced its outlook by $0.05 to ~$0.77 per share due to the planned devaluation of Venezuela's currency by 2 bolivars per dollar.

 

Pfizer

Merck & Co.

Stock 6 Month Change

+14.16%

-0.53%

P/E

14.1

19.1

EPS

1.94

2.16

Yield

3.5%

4.0%

ROE

11.6%

11.8%

What goes against Merck is its inability to develop new drugs successfully that are of significant commercial value. The delays (Odanacatib) and failures (Tredaptive) are testing shareholders' patience. The company doesn't have a potential blockbuster in its pipeline like Bristol-Myers Squibb (BMY) and Pfizer's Eliquis. And, Bristol-Myers looks to gain more out of this venture than Pfizer due to its size. At this point both companies are trading at rich multiples due to general equity market momentum rather than growth potential. The long term demographic shifts away from developed markets towards emerging markets and their far more lax views on intellectual property - especially Asians -- make the entire industry very expensive at this point in time and in the near future.

The hookup with Samsung for Merck is a means to generate lower capital cost revenue which is a real positive but investors should not be buying on that development at these prices. Far larger issues will need to play out first before making this a value play.

Source: Merck's Struggles To Replace Singulair Lead To Biosimilars