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Tickers in this Article: MRK, IDP

Many pharmaceutical companies have had some less than spectacular years in recent times. Merck's (NYSE:MRK) been one of the hardest hit as its pipeline has stagnated, and it suffers from the legal repercussions of Vioxx.

Merck's Product Pipeline
Over the years MRK's been one of the leading pharma companies. It develops, manufactures and markets drugs for asthma, fungal infections, diabetes, arthritis, osteoporosis, pain, hepatitis-B and cardiovascular diseases. It also provides pharmacy benefit services and makes Propecia (male pattern baldness) and Singular (asthma drug). MRK has also been active in the acquisition field. It signed a pact with Idera Pharmaceuticals (AMEX: IDP) to develop technologies for vaccines in cancer and other infectious diseases.

Merck also acquired two smaller research companies. GlycoFi, a specialist in the optimization biologic drug molecules, was acquired for $400 million, while Abmaxis, which focuses on monoclonal antibody products, was acquired for $80 million. Finally, MRK also acquired biotech firm, Sirna Therapeutics, for over $1 billion.

The hope is these acquisitions will build MRK's research operations and leverage other acquisitions to re-build a solid pipeline.

Bad News and Good News
Part of MRK's problem stems from the legal suits over alleged deaths due to Vioxx. Since pulling Vioxx from the market, the company has tried to replace these sales with the development of Arcoxia, another Cox-2 inhibitor, but Merck recently received bad news about the replacement. The FDA advisory panel rejected Arcoxia by a vote of 20-1 (non-binding).

However, there were some positive results in the quarter that may have been overlooked. Although sales only increased 5%, sales of MRK's hypertension drugs Cozaar and Hyzaar rose 11% to $835 million. Also, the drugs Gardasil and Januvia added $155 and $42 million.

The 4th quarter results also showed weakness with deteriorating sales of current drugs. Sales of Zocor, Merck's blockbuster drug, plunged 65% in the quarter to $371 million due to competition from generics. Earnings are still struggling. Gross margins fell in the 4th quarter by over 270 basis points with a rise in marketing, administration and production costs. Merck is looking at emerging markets such as India, China and Latin America to outsource a major part of its drug development program. Research and development costs rose 55% to $1.7 billion, mostly because of acquired research costs of $466 million. The overall goal is that these steep expenses will pay long-term dividends. (For more information, check out The Ups And Downs Of Biotechnology.)

Problems have been hovering over MRK, but the worst may be behind them. Growth over the next couple of years will still be uninspiring, however, for the long term it's doing the right things with its selective acquisition programs and high level of R&D spending.


The Future

The Street's estimates for 2007 earnings are $2.65 and $2.81 for 2008. A look at MRK valuation shows that the stock is selling a low valuation on several measures. Merck is selling at around 16 times trailing earnings, around a 32% discount to the industry median. On a price/sales basis, MRK is also selling at around a 19% discount to the industry median. Despite its low earnings growth, MRK is still returning around 25% on its equity, which is close to the industry median of 24. It also generates an enormous amount of free cash flow that gives them a lot of financial flexibility. For the patient investor, MRK is also paying a 3.3% dividend as it re-builds the pipeline to surge future earnings.

Merck is expected to announce sales and earnings this week. Street estimates are for $5.23 billion in sales and $0.63 in earnings. The time may be approaching to give MRK a second look as it appears to be on the way to healing some serious wounds from the past few years. As the economy slows and the stock market becomes more uneasy, pharmaceuticals will be a defensive posture for investors to seek.

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