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In the pharmaceutical industry, conventional wisdom says the more crucial a drug becomes to a company's sales growth, the more it hurts when that drug's patent expires. Several of Merck & Co.'s (MRK) top moneymakers -- Vasotec, Prinivil, Pepsid, and Prilosec -- are on the verge of losing patent protection, which allows generic-drug makers to sell knock-offs at a fraction of the branded drug's price. In all, patents on five drugs accounting for 25% of Merck's U.S. sales are slated to expire over the next three years. That would likely erode its profit growth dramatically, analysts agree.
But so far, investors haven't paid much attention to Merck's patent woes. The drugmaker's shares have recovered nicely since a first-quarter slump in the drug sector. Pharmaceutical stocks typically fare well in a bearish market for other stocks because they're seen as impervious to higher interest rates, economic conditions, and other factors. On Tuesday, May 30, Merck's shares closed at $75, a high for the year and just shy of the 52-week high of $81.
Last December, on a mild, sunny afternoon in New Jersey, when Merck gathered hundreds of Wall Street analysts at its idyllic headquarters in Whitehouse Station for the annual "pipeline review," it was riding a wave of confidence. Its stock price perched near that one-year high, and its arthritis pain reliever Vioxx was fast becoming a hit with rheumatologists. But ominous warnings about losing patent protection on five of its top-selling drugs permeated the meeting that day.
READY REMEDY?
"Merck has real patent exposure problems which are not going away," says pharmaceutical analyst Dr. Leonard Cohen, of Americal Securities in San Francisco. Cohen maintains a market underperform rating on the stock and doesn't own shares himself, he says. Even analysts with a buy rating on the stock have expressed concern about Merck's ability to overcome the patent exposure.
Vioxx is a remedy for those patent ills, the company says. It became the fastest growing arthritis treatment shortly after its introduction last year, generating $472 million in sales in 1999. But Vioxx is up against Pharmacia's and Pfizer's Celebrex, another new form of arthritis painkiller and one that got a lead on Vioxx when its government marketing approval came first. In studies comparing Vioxx to nonprescription painkillers, Vioxx has been shown to lower the chances of gastrointestinal complications. Celebrex studies also showed the same effectiveness.
To Merck's dismay, though, new evidence in Vioxx trials shows signs that the drug may increase the risk of heart attack because it doesn't have the anticlotting properties of standard painkillers. A simple aspirin combined with Vioxx may solve that problem, but the evidence could prompt the Food & Drug Administration to change the Vioxx prescription label. Merck stands by its study, which shows Vioxx' superiority to Aleve, which is clinically known as Naproxen, and other over-the-counter painkillers that can cause ulcers.
SET TO POUNCE?
"Vioxx remains the fastest growing arthritis prescription in the U.S.," says Merck's Gwen Fisher. But Pfizer's Celebrex is a close second. Pfizer could pounce on the latest data about Vioxx' lack of anticlotting properties as a reason why doctors should favor Celebrex. "There's no company better at negotiating sticky regulatory issues than Merck, but Pfizer is the best marketing company in the drug industry," says J.P. Morgan analyst Carl Seiden.
Although much of Merck's message late last year to analysts centered upon initial success of Vioxx, that drug's sales growth may be slowing slightly. In the latest three-month sales data from IMS Health, a prescription information company, Vioxx' share of the arthritis drug market stalled at 17%, while Celebrex remained at roughly 18.5%.
Vioxx isn't the only Merck drug in a dogfight. Its anticholesterol treatment, Zocor, faces an uphill battle against Pfizer's Lipitor, the world's top-selling cardiovascular medicine. Indeed, no matter where Merck turns, Pfizer seems to be there. In the cholesterol market, Zocor -- with $2.6 billion in U.S. sales last year -- was quickly surpassed by Lipitor, with more than $4 billion in sales last year, according to IMS Health. And analysts worry that Zocor could lose more ground. Without brisk sales from both Vioxx and Zocor, as well as three other drugs, analysts question whether Merck can sustain the earnings growth investors have come to expect from the pharmaceutical giant.
PROMISING COMBO.
To be sure, many analysts are bullish about Merck because it has a track record of satisfying investors and finding new revenue sources at all the right moments. That may be the case with its linkup to Schering-Plough. The much smaller drugmaker announced a collaboration with Merck that combines Schering's Claritin, a top-selling allergy franchise, with Merck's Singulair, an asthma medication with an impressive launch last year. Merck has been testing the combination for years and says the results are promising. There's also the steady success of Merck's hypertension combo, Cozaar and Hyzaar, with $1.7 billion in sales this year, and strong growth from Fosamax, the best-selling drug for osteoporosis.
"Merck can still make a lot of hay with Vioxx and its other drugs," says Edward Jones analyst Bob Kirby. "I think there's room in the arthritis market for both Vioxx and Celebrex." Still, Vioxx remains the key to offsetting the revenues lost to patent expiration. Major patented medicines typically lose half their sales in the first month after patent expiration and as much as 80% within a year.
The crucial issue is how well Merck can maintain Vioxx's growth in the face of stiff competition from Pfizer. Says analyst Leonard Cohen: "There's no question Vioxx will become a billion-dollar drug, the question is: Will it become a $2 billion or $3 billion drug?" If Vioxx doesn't succeed on a grand scale, Merck could find itself in a world of hurt.
Shook is a staff reporter for Business Week Online EDITED BY BETH BELTON
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