Merck's Billion-Dollar Bet

| About: Merck & (MRK)

Merck (MRK) signed a partnership with Endocyte (ECYT) Monday for the latter's cancer drug Vintafolide. The partnership will cost Merck $1 billion and it will give the company the right to develop and market Endocyte's drug globally. One caveat with the deal is that Merck will not pay all of the $1 billion upfront.

The company will initially pay a fee of $120 million, and the rest of the money will be paid in gradual payments, depending on the drug's success. In addition, Endocyte will receive royalties and other commissions from Merck after the drug gains FDA approval. Endocyte will be able to continue to produce and sell the drug in US, but not elsewhere.

This looks like a very profitable deal for Endocyte and it resulted in the company doubling its market value overnight. How about Merck? Did it also get a good deal?

Currently, Vintafolide is still in process of conducting medical trials. The drug is produced to treat later stages of multiple types of cancer such as ovarian cancer and non-small cell lung cancer. This drug targets folate receptors, which are related to multiple cancer types including ovarian, breast, lung, kidney and colon. This creates further opportunities for use of this drug. The drug comes with a diagnostic test and this test will be used to identify patients for who the treatment is most likely to be effective. The diagnostic test is able to identify individuals with highest expression of folate receptors. This drug is part of a new trend of treatments that focus on biological and genetic makeup of the patients rather than offering a one-size-fits-all solution. This is a completely new field and Merck sees a lot of promise here, particularly in treatment of difficult diseases such as cancer.

As Merck will lose exclusivity for its asthma drug Singulair by the end of the year, the company has been looking for new avenues to generate the revenue that will be lost. This could be an excellent chance for the company to see revenue growth. Cancer presents a huge market with unlimited opportunities. This is mostly because there is shortage of effective treatments for many cancer types and the disease is becoming more prevalent in the population.

As people live longer and get exposed to pollutants in the air, food and water more, the prevalence of cancer increases. This is particularly true for developing nations such as China and Brazil. For example, as of 2011, the leading cause of death in China is cancer as it causes every 5th death in the country. Also, keep in mind that many of the most difficult to treat cancer types are associated with over-expressed folate receptors and this treatment targets the same receptors. If successful, this drug will face great demand.

The plan is to get approval for Vintafolide in US, Canada and Europe before marketing the drug in other geographical regions. The company will try to get approval for the drug for 6 different types of cancers. Endocyte will pay for all the expenses for the approval process and Merck will pay for all the expenses after approval. Earlier this year, Merck formed a similar partnership with Ariad Pharmaceuticals (ARIA) for a cancer treatment (Ridaforolimus) that failed to win approval from a panel of FDA advisors. The final decision is not made on the drug yet; however many times FDA agrees with the suggestion of its advisory panels.

Merck is a relatively conservative company and it usually doesn't bet its money on projects it doesn't believe in. The company conducts its diligence in projects it gets involved with. The fact that Merck only paid $120 million until FDA approval can be obtained also demonstrates this point. In the past trials, the drug had better outcome than Johnson & Johnson's (JNJ) Doxil. The drug already has orphan drug status in Europe, which means that the company will have 10-year exclusivity on the drug if it gets final approval from European Medicine Agency (EMA). This will make sure that the competition can't get its hands on this drug for a pretty long time.

I am bullish on Merck and I hope that the company continues to build partnerships similar to this one. In the long run, this may end up being far more profitable than the company actually creating its own drugs.

Disclosure: I am long MRK.