Friday, January 27, 2012

Merck's 2003 Medco Deal: Interesting (If Mistaken) "Short-Sighted" Divestiture Thesis

While The Street's research (do go read it all -- beginning on page 3) is thoroughly-vetted, and well-sourced -- I don't buy the conclusion, primarily because the metrics examined, while accurately-reported, are. . . incomplete.

In short, I think Merck was right to divest Medco -- with my more complete explanation below the pull-quote:

. . . .It meant that by the time of the [Medco] spin, 63% of overall [Merck] revenue came from Medco. However, low Medco profit margins dragged on Merck's overall share pricess, leading to a radical shift in strategy.

After the spin, which gave shareholders one Medco share for every eight Merck shares, their stock prices and earnings abilities diverged. Medco's shares have gained over 500% since its Aug. 2003 initial public offering, while Merck's shares have fallen by nearly a quarter. As a result, even with Medco's subsequent stock gain, Merck shareholders have seen losses since the spin, when excluding dividend payments. . . .

Since the spin, Medco's sales are expected to have nearly doubled to $68.5 billion, while profits are expected to triple to $1.5 billion according to 2011 earnings estimates compiled by Bloomberg. Meanwhile, Merck sales have grown at the same rate, while profits have doubled, on the heels of big merger activity. . . .

[Then, for a variety of reasons,] Merck pulled the trigger on one of the biggest mergers in pharma history buying Schering-Plough for $41.3 billion in May 2009. . . .

However, with it came legal battles. In 2009, Merck and Schering-Plough settled a suit for cholesterol treatment Vytorin after allegations of withholding key clinical trial results. Merck also pleaded guilty to a criminal charge with the U.S. Department of Justice for its marketing of painkiller Vioxx before it was pulled in 2004.

In July 2011, Express Scripts announced a deal to buy Medco Health Solutions (MHS) for $29 billion in a deal to combine two of the largest pharmacy benefits managers in the U.S. However, the deal is facing antitrust scrutiny, which jeopardizes its outcome. . . .

All of the above is accurate, but the price performance disparity post-Merck's 2003 divestiture is, in my opinion, less a "short-sighted divestiture" example (the authors' thesis), and more a story about the overall decline of branded pharma margins, globally -- on the Merck side.

More directly, as the upper right graphic reminds us, and these stories (here, and here) document, the Medco relationship was fraught with conflicts of interest -- especially for a pure pharma with the visibility, scale and size of Merck. It ultimately put the company in the position of being a competitor to its customers. That will almost never work (longer term), and often leads to investigations, and scandals (as we've seen here).

A nice piece, just the same. Almost as if to undercut the authors' thesis, from their own concluding sentence on the topic (above), the ongoing anti-trust scrutiny of the pending Express Scripts/Medco tie-up would suggest that Merck was (again) right to hand this value package back to shareholders. Of course, "your mileage may vary" -- in fact, it probably does.


Marilyn Mann said...

This has nothing to do with this post, but I was surprised that you didn't blog on the FDA's decision to turn down Merck's request for a new chronic kidney disease indication for Vytorin and for Zetia when prescribed with simvastatin.

The FDA did permit a revision to the Vytorin label (on pp. 27-28 of the label) that states the results of the SHARP trial, but without an indication Merck won't be able to advertise the use of Vytorin for reducing the risk of cardiac events in CKD.

Condor said...

I just flat out missed it -- thanks Marilyn!

I'll post on it -- crediting you -- later today.

Again, thanks a ton!