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Dow 30 Profile: Merck
Merck’s (MRK - Free Merck Stock Report) roots can be traced all the way back to 1668, when Friedrich Jacob Merck purchased a drug store in Darmstadt, Germany. The business remained in the family for generations operating as a pharmacy until Heinrich Emmanuel Merck transformed the business into a drug manufacturing company in 1827. This is when Merck really started to take shape developing its first products which included codeine, cocaine, and morphine. By 1855, the company was known as E. Merck AG and its products were being used worldwide.
In 1877, E. Merck AG wanted to explore the possibility of expanding its operations to the United States, so it sent Theodore Weicker (who would later go on to own Bristol-Myers Squibb (BMY), to set up the company’s first sales office. In 1899, Weicker along with George Merck (grandson of Heinrich) acquired a 150-acre site in Rahway, New Jersey which would eventually become the location of its first research laboratories and corporate headquarters. The U.S. subsidiary was called Merck & Co.
In 1917, the subsidiary’s ties with the parent company were severed upon the entrance of the United States into World War I. In fear of anti-German sentiment, George Merck turned over a sizable portion of Merck stock to the U. S. Government; these shares ultimately represented the German interest in the company. At war’s end, the U.S. government rewarded Merck by selling the shares back to the public. By 1919, the corporation was once again entirely public-owned and George Merck retained control.
From 1920 through the 1950s, Merck grew substantially via mergers and research and development. The company was led by George Merck’s son, George W. Merck, and during his tenure the company made several promising discoveries including cortisone, vitamin B12 and streptomycin. Merck merged with the Philadelphia-based drug company, Powers-Weightman-Rosengarten in 1927 which increased Merck’s annual sales from $6 million in 1925, to $13 million in 1929. The company continued to utilize this growth strategy effectively in the years leading up to World War II, eventually becoming much larger than its German ancestor.
In the years following World War II, the company endured a period of sluggish growth. A lack of promising new drugs, coupled with increasing foreign competition caused the company to struggle during this time. A turnaround came in 1953 when Merck merged with fellow industry leader, Sharp & Dohme. This was a key moment in Merck’s history as the merger provided the company with a new distribution network and marketing facilities. It also allowed Merck to sell drugs under its own name. By 1957, the company was generating over $100 million annually in sales.
In the period from 1965 to 1976, Merck’s pharmaceutical operations began to struggle a new due largely to an ill-advised diversification strategy initiated at the time. The company acquired several businesses during this period, most of which were divested due to lackluster profits. A rebound would come in 1976 with John J. Honran, the new CEO. Mr. Honran stressed a renewed focus on research, which helped to spur strong growth through the mid-1980s.
By the late-1980s, Merck was undoubtedly a powerhouse in the pharmaceutical sector thanks to several consecutive years of double-digit sales gains. In 1988, Vasotec became the company’s first drug to top $1 billion in annual sales. In 1992, Merck introduced cholesterol-fighting drug Zocor which would become one of the most successful products in drug industry history. By 1999, Merck was the largest pharmaceutical company in the world, with overall sales exceeding $30 billion annually.
From the mid-1990s to 2009, Merck grew through acquisitions and the introduction of several highly-lucrative new drugs. As a result of consolidation within the industry, Merck had lost its title as “World’s Largest” in the 2000s and, in fact, found itself falling from the upper echelon. That changed dramatically in 2009, when Merck announced its blockbuster merger with the Schering-Plough Corporation.
On November 3, 2009, Merck completed its $41 billion merger with Schering-Plough marking one of the largest unions of the year (Second to Pfizer’s (PFE - Free Pfizer Stock Report) $68 billion purchase of Wyeth). The cash/stock deal was structured as a reverse merger, with Schering-Plough technically buying Merck, but the better-known Merck name surviving. This was a big move for Merck and a necessary one at that. With the industry quickly approaching one of the largest patent expiration cliffs in history, the pressure was on management to develop an effective strategy. As consolidation seemed to be the popular trend within the group, Merck followed suit.
Merck benefitted from this merger in several ways, but the most important had to have been Schering’s contribution to the pipeline. At the time, Schering-Plough was generating over $18 billion a year in total sales with a brand base that included Coppertone and Dr. Scholl’s. It also maintained exclusive rights to several profitable drugs like Zetia and Vytorin. With a fully-stocked pipeline, Merck was now much better positioned to absorb the impact of patent expirations in the years to follow. It also helped to reestablish the “Merck” name as an industry leader.
Today’s Merck is currently the second-largest healthcare company in the world with nearly 100,000 employees and revenues in excess of $45 billion annually. The company’s operations are principally managed on a products basis and are comprised of four operating segments; Pharmaceutical, Animal Health, Consumer Care, and Alliances. However, the Animal Health, Consumer Care and Alliances segments are not material for separate reporting and are listed as “All Other Segments” for accounting purposes.
The Pharmaceutical business is clearly Merck’s bread and butter, accounting for nearly 90% of total revenue. The segment provides human health pharmaceutical products in the areas of bone, respiratory, immunology, dermatology, cardiovascular, diabetes, infectious diseases, neurosciences, ophthalmology, oncology, vaccines, and women's health. Top-selling pharmaceutical products include Singulair, Remicade, and Zetia.
The Animal Health business discovers, develops, manufactures, and markets animal health products including antibiotics, anti-inflammatory, vaccines, fertility disorder treatments, and parasiticides for cattle, swine, horses, poultry, dogs, cats, and fish. The unit sells to veterinarians, distributors, and animal breeders.
The Consumer Care business develops, manufactures, and markets over-the-counter, foot care, and sun care products. Its over-the-counter product line includes non-drowsy antihistamines, treatment for occasional constipation, decongestant-free cold/flu medicine for people with high blood pressure, nasal decongestant spray, and treatment for frequent heartburn. Sun care products include Coppertone sun care lotions, sprays and dry oils, as well as the Solarcaine sunburn relief line. Foot care products include Dr. Scholl’s foot care, Lotrimin topical antifungal, Tinactin topical antifungal, and various other foot and sneaker odor/wetness products.
The Alliances business comprises of revenue and equity income from the company’s relationship with AstraZeneca (AZN).
In our view, the key focus for the year ahead will be the quickly approaching patent expiration of Singulair, which is scheduled for later this year. The company is still feeling the effects of generic competition for its blood pressure drugs Cozaar/Hyzaar, and the loss of Singulair is expected to add significant pressure to the top line. On the bright side, Merck has been one of the few drug companies to maintain R&D spending in its pipeline during the most recent recession and the slow, uneven business recovery that has followed. This investment should help mitigate some of the longer-term effects of patent expiration, as new products are developed and transformed into meaningful top-line components. Indeed, management plans to file five major drugs for approval between 2012 and 2013.
An Attractive Pharmaceutical Play
Due to its strong management and impressive track record, we are confident that the company’s recent product development efforts will be sufficient in ensuring long-term stability. At present, Merck maintains superior rankings in regard to Safety and Financial Strength. Income-oriented investors may find appeal in the stock’s attractive dividend yield..
At the time this article was written, the author did not have positions in any of the companies mentioned.