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Caught in The Wrong Job?
Merck Today stands at a Juncture where it Requires a Major Overhaul in its Strategic Outlook. Does Kenneth C. Frazier (its current CEO) have what it takes to Guide a Pharma Giant in times of Patent Expiry?
Issue Date - 09/06/2011
What if you happen to be the recently appointed CEO of a pharma giant in an era of patent expiry & dwindling healthcare policies? And what if, the blockbusters, which generate a quarter of your company’s revenues, are unfortunately poised to go off patent in the next two years? That’s exactly what Kenneth C. Frazier has been struggling since he took over as President & CEO of Merck & Co. from Richard T. Clark on January 1, 2011.

Although facing increased competition, patent losses, and a pipeline of late-stage drugs with poor chances of approval over the last few years, Merck had greatly improved its long-term outlook by acquiring Schering-Plough (for $49 billion in March 2009), but then the challenges remain for Frazier. Raison d’être: Still reeling from the patent loss on its hypertension drugs Cozaar & Hyzaar in early 2010, Merck faces the loss of its next top drug Singulair (for respiratory ailments) in terms of revenue generation in 2012. Considering Singulair represents over 10% of the combined sales of Merck & Schering, the blow will certainly make a big dent on the drugmaker’s topline. Further, Merck faces some remaining legal risk with Vioxx (its popular painkiller). While the majority of plaintiffs participated in the $4.85 billion settlement (in 2008), a few holdouts could ring up additional settlements and significantly hurt Merck’s net profit, which has already witnessed a significant fall, from $12.89 billion in 2009 to $861 million in 2010 (a pathetic 93% drop).

No doubt, indicating a shift in strategy, Frazier, on February 3, 2011, had announced an investment of $8.5 billion in R&D for 2011, but considering that Merck’s efforts to develop a reliable late-stage pipeline have yielded questionable results during the last couple of years, is it really a good bet? “Not really,” feel several critics. By doing so, Frazier has not only compromised the company’s EPS forecast for 2013, but has also offended the Wall Street, which responded back by cutting Merck’s stock price by 2-5% (from the date of announcement). Interestingly, around the same time, Merck’s competitor Pfizer had slashed its R&D budget to $6.5-7 billion from the earlier $8-8.5 billion. And investors awarded the move as the drug giant’s stock price increased by 5-7%.

Such market reaction can perhaps be decoded by expounding upon how this business is evolving. In 2010, the top 10 pharma outfits shelled out a total of $67.41 billion on R&D. In fact, according to statistics compiled by the Tufts Centre for the Study of Drug Development, spending to develop new drugs has been constantly growing over the years. But, what the data also reveals is that after the mid 1990s, new drug approvals have been falling steadily (only 16% win regulatory approval) and research pending has almost doubled in the last one year. This certainly explains the reason for the fall in Merk’s stock price.

If the issue still isn’t clear, then a little flashback might settle the remaining dust. In January 2011, Merck shutdown a study on Vorapaxar and took a $1.7 billion write-down on the drug (a blood thinner which was expected to bring in sales of upto $5 billion). Later in March, it shelved another blood thinner because competitors were way ahead of the development cycle. Further, the 8,000 patient trial of a Staph vaccine was also suspended soon after. All this clearly indicates that Frazier should now be rethinking his strategy. Even if he plans to invest heavily in R&D, it should be focused on a few drugs & executed in a better manner – if not it will continue to fail.

Surprisingly, Frazier looks content with the company’s orientation as he exclaims, “As a company, I think we are saying that we are committed to innovation as a strategy, and we believe that over the long term it will pay off”. But then, looking at its recent drug failures, the strategy does not promise Merck a sustainable future. For it, Frazier will surely have to change Merck’s course. Agrees Damien Conover, the US-based Associate Director of Healthcare at Morningstar as he tells B&E, “Merck’s near-term risk largely centers on market acceptance of new products. Like all pharma companies, Merck faces regulatory risk from the FDA. Product delays or nonapprovals could further hurt the stock.”

So, what’s the remedy? A possible solution might be acquisitions of companies with the potential to manufacture generics in countries like India where the government allows 100% FDI in pharma. By doing so, not only will Merck recover money that it’s losing on account of blockbusters going off patent, but can also significantly ramp up investments in R&D (provided it converts these acquisitions into cash cows).

For now, the company believes that R&D is where the future lies, but any move which might indicate otherwise will have long term repercussions. For instance, in April this year, Merck announced that it would be buying back stock worth $5 billion. The market did not react positively to the announcement. Reason: In case Merck is really concerned about long term sustainability (its argument for investing in R&D), then why in the first place did it opt for a buyback when the dollars could have been invested into more research? In fact, in a recent blog post titled Merck and Pfizer: Thoughts on investing as patriotic duty and market efficiency, Prof. Aswath Damodaran who teaches Finance at the Stern School of Business voiced his concern when he wrote: “Perhaps, the worst thing that Merck can do now is take other actions that are inconsistent with its current actions, in terms of future direction. Such actions would contradict the return to R&D roots story that they are pushing.”

Further, the problem with Merck is its CEO’s non-science background. Frazier has spent a sizeable part of his career fighting law suits, first as an aggressive litigator at Drinker Biddle & Reath (a Philadelphia based law firm) and then at Merck since 1992 where by 1999 he was promoted to legal counsel. No where does his resume have traces of operational or scientific experience. This perhaps gives Merck a little room for strategic maneuverability.

Thus, with Frazier’s lack of scientific expertise coupled with Merck’s recent failures with some drugs, which were supposedly meant to be the blockbusters, it’s really high time for Merck to look at Plan B instead of blindly investing in R&D. Well, we hope they have one!


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