Is Merck Actually "Fully-Valued" At $37?

Thesis: Merck seems fully valued at anything over $37.

It struck me, overnight, that yesterday, Merck agreed to give up 50 percent of about $4.8 billion in worldwide animal health sales, from Intervet (to Sanofi-Aventis, via the New Merial Joint Venture) -- in perpetuity, too! -- for a single $1 billion payment, near the end of 2010, or early 2011. That makes for a weaker future Merck earnings hand, I think:

Half of that $4.8 billion a year is $2.4 billion in sales. That is what Merck gave away for $1 billion upfront.

If the $2.4 billion in Intervet animal health sales garner only a 25 percent margin (and that number may well be higher), Merck gave away $600 million per year, every year, of gross profit. In just the next three years, then -- Merck has agreed to forego $1.8 billion of gross profit -- and Whitehouse Station only garnered $1 billion upfront for giving away gross profits of call it $3 billion, over the next five years.

Importantly, all of that assumes Merck and Sanofi-Aventis and Merial won't have to divest too many animal health franchises, to clear antitrust hurdles. On the other hand -- if the parties divest (as some expect) as much as one third of the animal health business, Merck's annual return (on its half of the New Joint Venture) will drop by another third, or another $100 million of gross profit per year, foregone.

[True enough, Merck will receive 50 percent of the profit on the lower margin Merial animal health products sales -- as an offset, but I think the above overwhelms those, in the longer run. Recall that Merial's sales are closer to a flat $4 billion a year, in perpetuity, and are generally lower margin consumer (pet) products. Merck's Intervet is generally comprised of higher margin live-stock products.]

And so, when we add in the looming $16.8 billion patent cliff, and the slower timeline on TRA, $37 is full value, IM(NS)HO.