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Merck Could Use a Few Pep Pills


Merck & Co. (MRK) has a history of going its own way in the drug industry. It was the first big drugmaker to buy a pharmacy- benefits management business, now called Merck-Medco, back in 1994. It has pushed aggressively into risky new research fields, conducting one of the biggest projects to find an HIV vaccine. And while big rivals such as Pfizer Inc. (PFE) and Bristol-Myers Squibb Co. (BMY) have tried to keep their new-drug pipelines flowing by pulling off major mergers or striking expensive development deals with smaller outfits, Merck Chairman and CEO Raymond V. Gilmartin has relied largely on the company's vaunted research labs.

Wall Street, however, is now questioning that independent streak as Merck enters a critical period. Patents on several of its blockbuster drugs have been expiring, exposing them to competition from cheap, generic knockoffs. At the same time, the company's pipeline looks alarmingly thin. Merck had counted on its second-biggest product, arthritis drug Vioxx, to help it through this rough patch, but now its fast growth is stalling.

"ONE-TWO PUNCH." That's why investors are anxiously awaiting Merck's annual meeting for analysts on Dec. 11. If the company doesn't unveil exciting new developments about potentially big drugs, the pressure quickly will mount for Merck to consider acquisitions or major drug-licensing deals. But the options aren't promising. Schering-Plough Corp. (SGP) is often mentioned as a target, but Merck has felt that big purchases can be more trouble than they're worth. And licensing deals are difficult to find and pricey to seal. "The one-two punch is that they have so much patent exposure but not a lot in their pipeline relative to their size," says Norman M. Fidel, health-care portfolio manager at Merck shareholder Alliance Capital Management LP. "We are looking at the valley and we just don't see a lot on the other side." Gilmartin declined to comment ahead of the analysts meeting.

That reality is pounding Merck's stock. So far this year, the price is down 27%, to around $69 a share, while the Standard & Poor's Health Care Index is off 10%. Richard T. Evans, an analyst at Sanford C. Bernstein & Co., warns that Merck's net income will climb just 6.7% this year, to $7.3 billion, on sales of $47.3 billion, a 17% jump over last year largely due to fast-rising--but lower-margin--sales at Merck-Medco. Next year doesn't look much better, with net income and sales both expected to rise just 8%. SG Cowen Securities Corp. expects Merck's earnings growth to average 9% from 2001 through 2005, well below the 13% industry average and the 17% that the company itself has averaged over the last four years.

The stumble is hardly surprising considering the number of Merck products losing their patents. Last year U.S. patents expired on the stomach drug Pepcid and the hypertension drug Vasotec, which grossed a combined $1.7 billion in the U.S. in 1999. Next year Merck loses market exclusivity in the U.S. for its hypertension drug Prinivil, which is now racking up $1.1 billion in U.S. sales. And, depending on the outcome of a court case, generics may also erode profits next year from the AstraZeneca PLC blockbuster stomach drug Prilosec, which Merck shares thanks to a joint venture. Analysts figure that Merck's portion of Prilosec sales will hit $1.2 billion this year.

Merck was depending on Vioxx to help keep the growth engine humming. Part of a new class of painkillers called Cox-2 inhibitors, Vioxx was launched in 1999 on the heels of a similar drug, Celebrex, now owned by Pharmacia (PHA). Both drugs were immediate hits. Then, last year, a study by Merck showed how easy Vioxx was on stomachs, the drug's main selling point, but also indicated that patients taking Vioxx were more prone to heart attacks than patients taking an older, rival, drug. Merck believes that Vioxx doesn't cause heart problems--that instead the older drug may actually help protect the heart--but a study to prove that point has not been done yet. So in September the Food & Drug Administration warned the company that its marketing must acknowledge that it is unclear whether Vioxx poses a cardiac risk. Merck has started doing that, but director and Honeywell International Inc. (HON) Chairman and CEO Lawrence A. Bossidy says the board believes the cardiac issues will be resolved. "The board has a lot of confidence that it will be a great drug."

Still, the uncertainty is hurting Vioxx in the marketplace. In June, Merck conceded that the drug's sales would come in at the low end of the $3 billion to $3.5 billion range it had laid out for this year, though that's still higher than last year's $2.2 billion. Since then, however, some analysts have pared their sales estimates to as low as $2.6 billion. SG Cowen analyst Stephen M. Scala has slashed his earlier $4 billion estimate for Vioxx sales in 2005 by $1 billion. Partly that's because some health maintenance organizations have balked at the high price of Cox-2 drugs and are restricting them to patients at risk of stomach problems. But with the uncertainty about cardiac problems, some physicians are prescribing less Vioxx.

As Vioxx's potential fades, does Merck have another superdrug up its sleeve? Peter S. Kim, executive vice president of research and development, says Merck will disclose some promising new drug candidates now in early human testing at the Dec. 11 meeting. "It's premature to jump to the conclusion that Merck has a problem in its pipeline," he says. Still, based on what Merck has disclosed so far, the near-term pipeline looks lean. It includes a new Cox-2 drug called Arcoxia that may be more effective than its competitors but which may face the same cardiac questions dogging Vioxx, and a new antidepressant that could be a blockbuster but is far from a sure thing.

In a few years Merck will face yet another major setback: the end of U.S. patent protection for its biggest drug, the cholesterol-lowering Zocor, which is worth $6.6 billion a year. Generics are expected to hit in the middle of 2006, and while that may seem far away, by then Zocor is expected to account for roughly a third of the company's total drug sales. To head off that threat, Merck is linking up with Schering-Plough to create a pill that combines Zocor with a new cholesterol medication from Schering. The combination is expected to be more potent than Zocor alone and Merck will try to switch patients to the new therapy--which will enjoy years of patent protection--before Zocor generics hit the market. But there's a pitfall: Even if the combination is a hit, Merck must split the profits with Schering.

LICENSING DEAL? That's why a number of analysts say it makes sense for Merck to buy $10-billion Schering. It would hold onto all the profits from the new Zocor combination therapy and generate big cost savings to help boost earnings during a period of weak growth. But Merck's Gilmartin has maintained for years that Merck is better off developing its own breakthrough drugs rather than jumping into the disruption of a megamerger. Schering declines to comment. Dr. John R. Borzilleri, a senior vice-president at State Street Research & Management Co., a Merck investor, says Gilmartin could instead buy a smaller European pharmaceutical company to fill its pipeline in the near term. Or Merck could sign a deal to market a product being developed by a smaller company, as Bristol-Myers did recently with a promising cancer drug in the works at ImClone Systems Inc. (IMCL) But potential blockbusters aren't plentiful and don't come cheap. Says Borzilleri, "There are a lot of people looking to [acquire or license drugs], so they could find themselves in a bidding war."

With no quick fix in sight, Merck is focusing on energizing its research efforts. The company has recruited new scientists, most notably the 43-year-old Kim from Massachusetts Institute of Technology, who has done groundbreaking work on HIV. Kim is expected to take over Merck's massive R&D operation after the current chief, Dr. Edward M. Scolnick, 60, retires in the next few years. The company has also signed a series of deals to bulk up its scientific expertise. Earlier this year, for example, it bought Rosetta Inpharmatics Inc., a genomics company.

None of this, it appears, will plug the near-term hole in the pipeline. So is it time for Merck to break with tradition? "They desperately need to acquire product," says Borzilleri. "I don't see how they do it on their own." If Merck doesn't soon have a breakthrough or two to wow Wall Street, that criticism will grow only louder. By Amy Barrett in Philadelphia


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