Dueling Fools
We Can Merck It Out
November 11, 1998

Merck Bear's Rebuttal
Chris Rugaber ([email protected])

If Merck is like an aging veteran athlete past his prime, Paul Larson is the old guy in the stands reminiscing about all the athlete's glory years, while his grandchildren wonder if that recent knee injury just might be a problem.

Merck is certainly cheaper than its pharmaceutical industry cohorts, but there are reasons for that, most of them listed in my opening arguments. But let me quote a pharmaceutical trade publication on the main reason why: "Merck is the only major U.S. drug company likely to sustain decelerating earnings per share momentum." Sales growth may slow from 19% in 1997 to 8-10% by 2001.

Clearly, losing patent protection is no fun. It doesn't mean you lose all your revenue from the product, but you will lose most. For example, Glaxo Wellcome, the world's largest drug company, grew only 3% the year their big gun, Zantac, lost its patent. As Jeff Fischer pointed out in the Fool's Industry Focus 1998, generic drugs -- the kind that can be made when a patent expires -- are different than other generic products because they have to be of equal quality; they're not hit-or-miss knock-offs. (Industry Focus 1999 will be on sale in December -- watch for it!) And by 2001, Merck's five patent-losing drugs may be providing as much as a third of its operating earnings, which gives you an idea of the company's impending troubles.

So regardless of what the rest of the industry looks like, paying 27 times next year's estimated earnings for a company that is likely to end up with growth in the single digits 2-3 years from now is not my idea of a good investment. You pay a premium on a company because you think it will continue to grow strongly, which Merck is unlikely to do.

Let's look at the recently released third quarter results, which in my opinion pretty well summarize both the good and bad of Merck.

On the good side, the company did grow revenues by 15%. Its leading drug, Zocor, did slow its loss of market share. And its new drug for asthma, Singulair, did "exceptionally well," according to a Hambrecht & Quist analyst, producing $55 million in revenue for the quarter. Other drugs, such as Fosamax, which treats osteoporosis, and anti-hypertension drugs Cozaar and Hyzaar also increased sales.

But then there's the bad side. Without Merck's Medco managed care business, and a shift in accounting related to the restructuring of their joint venture with Astra AB, a Swedish concern, sales growth would have been in the single digits.

In addition, Merck sold only $24 million worth of its new anti-hair loss drug, Propecia, despite an extensive TV ad campaign; plus, its new migraine treatment, Maxalt, sold only $15 million. These numbers are below analysts' expectations. Given the need for products like these to replace soon-to-be-lost revenue, these results are not reassuring.

Merck's drugs that aren't losing patents do not reassure one either. While Zocor's loss of market share may have been slowed, according to the Dow Jones Newswire its 15% growth rate is down from previous growth rates of 25% to 30%. And Vasotec, another anti-hypertension drug, dropped 22% in sales. Ouch! This simply increases the pressure on Vioxx, and investors ought to be wary of a company that has too many eggs in one basket.

Merck has been a great stock for those smart or lucky enough to buy it during the days of the proposed Clinton health plan, when it was at a low point. But its glory days may be over. Investors in Merck may need its migraine medicine, Maxalt, over the next few years, which ironically would at least help its sales.

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