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Transparency/Disclosure: I was compensated modestly by ChromaDex Corporation to write this article. While I have vetted each company, researched it thoroughly and I've done my own due diligence, my due diligence is not a substitute for your own.

Merck (NYSE:MRK) has recently endured a few difficulties within the pharmaceutical industry, from drugs not passing FDA approval, to increased competition from generic drugs. These struggles lead me to believe it is smart to stay away from Merck stock, though I think investors should still keep an eye on the company. I do see room for a change in strategy for Merck, which could lead to improvements in profitability and shareholder value.

Merck has recently faced a setback regarding its experimental treatment for bone cancer. According to its exclusive license agreement with Ariad Pharmaceuticals (NASDAQ:ARIA), Merck is responsible for the development and commercialization of the treatment, called ridaforolimus. The Food and Drug Administration recently rejected the application for investigational treatment using ridaforolimus for patients with soft tissue or bone sarcoma. This treatment is meant to slow the growth of bone cancer in patients who have already received chemotherapy.

The ridaforolimus drug is intended to compete with GlaxoSmithKline's (NYSE:GSK) drug Votrient, originally a kidney cancer pill that has recently been approved for use on soft-tissue sarcoma cancers. While Votrient halted the spread of the cancer for about three months longer than the placebo treatment, ridaforolimus only slowed the spread three weeks longer, and some patients experienced heart, liver, and kidney disorders. Based on these reasons, the FDA stated Merck must complete further clinical trials before approval will be considered.

While ridaforolimus is not yet ready for approval, CEO Kenneth Frazier is still very confident in the treatment, and expects FDA approval in the future. This could eventually lead to new and profitable revenue streams for Merck, which should lead to greater returns on investment for shareholders. Another promising opportunity, possibly even more so than ridaforolimus, is the experimental insomnia medicine that will be up for approval later this year. The drug maintained effectiveness for a full month in a late stage clinical trial.

Merck also plans to apply for approval of Bridion, a medicine aimed at reversing the effects of anesthesia, along with five other experimental drugs over the next couple of years. All of these drug approvals have the possibility of leading to huge revenue streams, since many approved drugs are granted a 20-year patent.

Merck recently filed a litigation suit against the Sandoz unit of drug maker Novartis AG (NYSE:NVS) and Intas Pharmaceuticals. This lawsuit is an attempt to block the production and selling of a generic form of Emend, a drug developed by Merck to prevent nausea and vomiting from chemotherapy. Merck believes the selling of these generic drugs violates two patents held by Merck that do not expire until 2015 and 2019, respectively. If the court sides with Merck, it will lead to continued revenue streams that have been very profitable for the company so far.

Unfortunately for Merck, top selling asthma and allergy medicine, Singulair, will be forced to compete against generic versions of the drug starting in early August, when its patent expires. Singulair brought in $5.5 billion last year, a number that is certain to drop once the generic drugs hit the market. This will definitely hurt Merck's profitability, but CEO Frazier is confident Merck will continue to move forward.

Merck is not a stranger to losing bestselling drugs to generic brands, as it lost the osteoporosis drug Fosamax in 2008 and the cholesterol pill Zocor in 2006. As with the expired patents of those two drugs, Merck will look to develop new, innovative medicines, and increase sales of its existing drugs in the face of the generic drug competition.

At the company's annual meeting, CEO Frazier made sure to note the success of Januvia, Merck's family of diabetes pills. They have become the number one selling medicine of all branded diabetes drugs. While competition is always improving and entering into the market, it appears that Merck's diabetes pills will continue to bring in a steady stream of revenue.

There is, however, an alternative route Merck may take in pharmaceuticals to become more profitable. Most of Merck's business right now involves researching and developing diseases and the drugs that could potentially cure them. This is obviously very risky, and very expensive. It can take up to a decade, and over $4 billion to develop a single drug. Furthermore, there is an 85 percent chance each drug they develop will fail and not be FDA approved.

One alternate route many pharmaceuticals, including Merck, take is that of acquiring the rights to newly FDA-approved drugs. This alleviates almost all of the risk of the R&D stages since the FDA has already approved the drugs for sale. However, this is still a very costly route, as the companies that carry out all the research and development will need to be compensated for all the potential profits, and for what they have already spent.

Therefore, Merck and other companies should look into acquiring the rights to drugs just a short time prior to their approval. While this is more risky than acquiring them after approval, the prices they pay will be significantly smaller. Instead of spending billions of dollars on R&D, or on acquiring FDA-approved drugs, Merck would be able to spend a fraction of that money to assess the drugs being developed by others, figure out which of those it expects to be approved, and how much risk of failure they have.

While it would take some work to restructure its system of research and analyzing risk-reward management, using this strategy could greatly increase Merck's profitability. One such example of a company Merck may invest in is Ampio Pharmaceuticals (NYSEMKT:AMPE). Ampio is currently developing three drugs that have the potential to be hugely successful. Ampio has had excellent, statistically significant turnout from its clinical data, and the company's testing process has great fundamentals - both of these show promise for Ampio's drugs, which is why these drugs may be good acquisitions for Merck.

Another company to keep a close eye on is ChromaDex (OTCQX:CDXC), which supplies natural products and ingredients to the pharmaceutical industry. The company recently reported positive news on its primary ingredient pTeroPure, a powerful antioxidant. After a two month study involving 80 adult subjects, pTeroPure showed a "lack of adverse reactions and no major adverse events." While the release of pTeroPure's health benefits are still months away, the stock saw a surge in trading volume after the release of this news. ChromaDex appears to have a bright future, and I highly recommending buying the stock now.

I recommend keeping an eye on Merck, as there is definite room for improvement within the pharmaceutical industry. The pharmaceutical giants could transform their strategies into a more profitable business model, where they spend less on research and development, and more on finding potentially profitable drugs and acquiring these drugs prior to their FDA approval. In transitioning to more of this type of business, Merck would become a company I would recommend investing in.

Source: Keep Your Eye On Merck