Wednesday, April 27, 2011

Merck's $5 Billion Stock Buyback: "Whitehouse Station has no higher use for that capital"?

As we await the Q1 2011 earnings webcast in two days, Merck is presenting before an FDA advisory committee -- about approving boceprevir (Vertex's telaprevir is to be presented tomorrow); Merck's North Carolina operations are adding 150 jobs -- as the manufacturing operations expand away from the West Point, PA facility. . . and Merck said this morning it will buy back an additional $5 billion of its stock over the next few years -- bringing the total outstanding buyback authority to $6.4 billion. See Reuters, on it:

. . . .Merck said on Wednesday it plans to buy back up to $5 billion in shares, bringing its total share buyback program to $6.4 billion.

The Whitehouse Station, New Jersey-based drugmaker said the stock purchase has no time limit and will be made on the open market, in block transactions or privately negotiated transactions. . . .


I've long felt that vast buybacks are in some ways an admission of defeat by management. How so?

Well, by using cash to buy stock back, that cash will then definitively only generate a return that matches the average of all bets the company has made. It is afterall, simply betting on the company. In smaller proportions, this betting can be opportunistic. At $5.4 billion, it seems to suggest that Merck can't think of any investment which would generate a return ABOVE the company average -- so it throws in the towel, and buys back its own stock, hoping that the scarcity of shares in the float will drive up stock prices at least marginally, by soaking up some supply.

Why isn't that same $6.4 billion slated to build new plants, or launch new products, I ask.

I answer myself simply by saying -- there must not be many new products of size that need new plants. Similarly (and this is plainly a false premise), Merck must think there aren't other companies to be had, at a reasonable price, that would return more than the company's internal hurdle rate for equity capital.

We know -- from scanning tha deal sheets, that cannot be true.

So my advice to CEO Ken Frazier, and to Merck? Get acquisitive. And do so now, in size. You've $5 billion to toss around. Go make some bets. Viz (as of December 2010 -- just a few examples of companies with higher projected near term returns on capital):

That was from Christmas time 2010 -- sort of prescient, no? To be clear, I am not advocating the outright purchase by Merck of any of these specific companies (many of them are now led by ex-Schering-Plough executives, so that should be fair warning!). But there are hundreds, if not thousands, like them out there. Take a chance, Merck.

[Of course, the bit of H.L. Mencken in me also thinks it might well be that the buyback announcement, and the 150 new jobs in North Carolina, are PR hedges against a finding at FDA that suggests boceprevir needs an additional Phase III study before approval, or that come tomorrow, Vertex's telaprevir is shown to be the plainly superior Hep C candidate.]


Anonymous said...

A Food and Drug Administration advisory panel voted 18-0 Wednesday to recommend approval of Merck’s experimental hepatitis C drug Boceprevir.

The FDA is not expected to make a final decision on Merck’s new drug application until next month, but the agency typically follows the recommendations of its advisory committees.

Read more: FDA panel gives nod to Merck hep C drug | Philadelphia Business Journal

Anonymous said...

Now that the dust is starting to settle a bit more what do you think is next for Merck? Remicade issue has been resolved; Animal Health is to stay in house. Obviously, you'd prefer Merck to invest some cash in growth rather than purchase stock. What do you think makes sense for Ken Frazier?? Finish bust up of Schering by selling consumer business? Follow Pfizer's lead and bust New Merck apart??

Condor said...

I think I said somewhere that I didn't expect any Earth-shattering news from Whitehouse Station, on any of its business lines, so long as Q1 2011 earnings were on track.

And they were, this past Friday.

I see a fair amount of small-scale pruning still to be done by Frazier, business by business -- but no massive moves, near term.

He has reaffirmed that Consumer Halth is a core business, at New Merck, but in the same breath would not rule out a partner -- so, if there is a deal of size yet in 2011, it might be a co-venture in Consumer Health.

It seems that most or all of Animal Health might also be partnered up, or spun-off -- in 2012 or beyond.

Relatedly, Q1 2011 earnings were actually in-line, not a "beat" (as claimed by Merck, on a non-GAAP basis) -- when one considers the quarter-by-quarter management discretion now available at the R&D expense line -- for more on the "fuzzy math" in the Q1 2011 EPS "beat," see my later post here.

Namaste -- and great set of questions, Anon.!