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.

The Long-Delayed Daxas® News: Merck Drops EU And Canadian Rights

As my erstwhile commenter once again notes, it wasn’t likely to be a blockbuster for Whitehouse Station (as a legacy Schering-Plough candidate). . . but disappointing that UK’s NICE doesn’t see the cost/benefit for it, in any event.

So not one euro (or Canadian dollar) of net revenue — from the rights to Daxas^® — will ever reach the combined Merck bottom-line. Sigh. Here is a bit of an early January edition of the pharmaletter (do go read it all), on the topic:

. . . .Japan’s largest drugmaker, Takeda Pharmaceuticals says that it has reached a mutual agreement with US drug giant Merck & Co., which is known as MSD outside the USA and Canada, to terminate their co-promotion agreement for Daxas (roflumilast) in certain European countries and Canada as of December 31, 2011.

MSD will return the rights to Daxas, a once-daily tablet for patients with chronic obstructive pulmonary disease (COPD), to Takeda in all countries covered by the agreement. Under the terms of the original deal between Merck and then independent Swiss drugmaker Nycomed, Nycomed received an undisclosed upfront fee from Merck and became eligible for certain payments based on defined regulatory and commercialization milestones for Daxas. . . .

So it goes. [I am sorely tempted to say something about Ex-CEO Fred Hassan's non-discerning eye here, but I won't; you already know the drill if you've been following along these past few years.]

I’ll try to keep these items more current, from here on. Apologies.

Excellent Daxas® Follow-Up Analysis, From An Anonymous Commenter

One of my favorite anonymous commenters offers us a great update — and on a legacy Schering-Plough COPD candidate story that I completely missed. Of course, Pharmalot had it and I missed it there too. In any event, here it is:

. . . .I missed it too and was made aware of it today based on Pharmalot’s news regarding the recent Daxas^® lack of approval in the UK.

Not a big player for Merck but I also noted that Merck has also taken their CXCR2 antagonist off their clinical pipeline chart (legacy S/P compound).

The only COPD drug left is the inhaled steroid/LABA (Dulera, Zenhale and Foradil). [Which is] just a retooling of the asthma medicine.

Interesting — I wonder if they’re giving up on COPD?

January 25, 2012 11:06 AM. . . .

While I doubt that Merck is giving up on COPD meds altogether, I do think this is quite a come-down from the COPD program’s status at legacy Schering-Plough, as most recently outlined here in April of 2010. That former Merck Daxas^® distribution partner, Nycomed, is also where an ex-Schering-Plough GC has landed, as of November 2010 (see related graphic, at right — I think Nycomed still handles Alvesco^® — anyone know?).

Again — thanks to our erstwhile readership, this place is always made a better (if opinionated) resource.

Will Supremes’ Novartis Overtime Case Settlement Mean That New Merck Will Settle, Too?

As Ed at Pharmalot reported earlier in the week, Novartis will pay $99 million to settle its long-running fight with sales reps — over back overtime pay. Here’s Ed, then — on Novartis:

. . . .The move is significant because, until now, drugmakers have been fighting efforts by their current and former sales reps to win overtime pay. The topic has divided the courts and there have been so many conficting rulings that the US Supreme Court agreed last November to review the debate. A ruling is expected this summer. Ironically, the Supreme Court had earlier declined to review the decision in the Novartis case (here is the 2006 lawsuit filed by the Novartis reps).

At issue is whether sales reps are exempt from overtime provisions of the Fair Labor Standards Act. The FLSA overtime compensation requirement does not apply to employees who work as outside salespeople, but the law does require employers to pay overtime for hours worked beyond 40 hours a week, unless a FLSA exemption applies. . . .

Since the time of the original Schering-Plough complaints, Novartis, New Merck (the entity now responsible for the Schering-Plough overtime claims) and many other pharma concerns have restructured their sales reps’ duties, hours and roles to bolster the case that at least the currently-serving US reps are not entitled to overtime. So, this would be only a “look-back” settlement (should it occur), not a “look forward” settlement amount.

Importantly, even at $150 million, would be decidedly immaterial to New Merck. I do think the $99 million Novartis legacy sales rep settlement suggests that many of these cases (including the legacy Schering-Plough ones) are ripe for any number of agreed settlements. And Chairman/CEO Frazier has shown he is looking to put past Schering-Plough troubles very-firmly in the rear-view mirror — by settlements.

You read it here first, if it turns out this way, friends — perhaps even as soon as the February 2, 2012 Merck year-end results earnings call.

Merck’s Dividend Is NOT At Risk: What Is Austin Smith Smoking? Oh. Right. He’s A “Fool!”

In a generally “clue-free” piece for the Motley Fool, one Mr. Austin Smith offers a headline today that blares “The Dow’s Scariest Dividend?” — and makes Merck Exhibit A.

That notion — to coin a phrase — is um. . . foolish. His argument, such as it is, is that Merck’s earnings levels won’t support the dividend payout, because the dividend is about 110 percent of Merck’s trailing 12 months’ GAAP net income. Of course, to get to GAAP net income, one must deduct even one-time, non-recurring, charges. Charges like transaction-driven (think Schering-Plough bust-up, here) intangibles-and-goodwill write-downs (entirely non-cash), and headcount reduction charges (only partially a cash charge). [The dividend-payment, of course, is a cash item -- so we need be primarily-concerned about Merck's ability to throw off cash here. And that ability seems safe, for now.] Indeed, last year, several one-time largely non-cash charges reduced GAAP net income below the dividend burden by about 10 percent.

Yawn.

What Mr. Smith also neglects to mention is that Merck is significantly under-levered (i.e., carries a lower debt burden), compared to what would be a truly risky dividend company. Merck’s debt to equity is only 31 percent; its current ratio (coverage of its current debt) is over 2 to 1. Those are the most-relevant cash-deploying metrics. And these are generally solid, on a fundamental basis (as to dividend safety, at least). It is almost. . . boring. [I actually suspect that these pieces are largely auto-written, by a piece of software that simply churns through industry-groups, and looks for pre-set, brainless trip levels, on GAAP results -- then people like Mr. Smith review, edit and sign their name to them. Every so often, one sees one of these Fool pieces in other sectors -- usually just as clueless.]

In any event, here is a bit of Mr. Smith’s poorly-researched take, from this morning:

. . . .The first thing that jumps out at me on this list is Merck. The company has a payout ratio of 111% and it’s grown its payout ratio 70% over the past five years despite an 18% retraction in net income over the same period. This doesn’t actually mean it grew its dividend, though. The biggest reason is that the company maintained a roughly $0.38 dividend for the past five years despite a decline in net income. Although it has an appealing 4.3% yield, I think it’s fair to call it the shakiest dividend on the Dow. Its weak five-year performance isn’t encouraging, either. . . .

For dividend investors eyeing the Dow right now, I’d steer clear of Merck. . . .

That’s absurd. If you aren’t too concerned about near term NYSE price appreciation, Merck will always throw off a solid dividend. That much is a near certainty.

As I say, this is simply a very poor piece of financial analysis pretending to be journalism. And I’ve made this observation before — (about a year and a half ago). Merck is a safe, if unexciting dividend play, even in the now nearly unimaginable deflationary scenarios.

Let me say it one other way — Merck’s board would sooner think about an in-place, consensual bankruptcy reorg, before it would think about eliminating the dividend. There are a million other levers the board could pull, before it ever considered a dividend reduction. As a result of Merck’s size and scale, the board would have tons of better options to right the ship — even in a global depression; they’d be (how should I say this? um. . .) foolish to do otherwise.

Here endeth the lesson.

Whitehouse Station Proposes To Settle Canadian Vioxx® Cases

Not terribly surprising — it seems the Canadian Vioxx^® claims will likely settle shortly. It is consistent with the evolving approach under Chairman Frazier — per Merck’s presser, this evening:

. . . .”This agreement is structured to provide certainty and finality toward resolving Vioxx cases in Canada for a fixed amount,” said Bruce N. Kuhlik, executive vice president and general counsel of Merck. “Under the agreement, there will be an orderly, documented and objective process to examine individual claims to determine qualification.”

If the agreement is approved and specified conditions are met, Merck will pay a total amount of at least C$21,806,250 but not more than C$36,881,250. This would resolve all Vioxx certified class actions, putative class actions, other litigation and claims related to Vioxx in Canada.

The amount to be funded for Vioxx users in Canada will be between C$11,306,250 and $26,381,250 and will be determined by the final number of eligible claimants. Claims for myocardial infarction and sudden cardiac death will be evaluated on an individual basis by an independent administrator based on objective criteria related to various factors, including duration of Vioxx use, age and presence of risk factors. Individual awards for ischemic stroke claims will be a uniform amount not to exceed C$5,000. . . .

So — looking pretty much like the evolving US approach — in those later ENHANCE-era cases.

SOPA And PIPA: Crushed By The “Tubes” — Yes Schering-Plough, Your Corporate Logos Have Always Been Subject To “Fair Use” Rules

I am fairly certain that, as most-recently drafted, both of these bills (SOPA, and PIPA — see links in quoted text) would have ultimately been held unconstitutional insofar as they purported to prohibit citizens (i.e., natural persons — especially those not deriving any profit therefrom) from making incidental use of a corporation’s identity, marks, brands, logos or other intellectual property — when factually criticizing them (especially for the purpose of accurately identifying the maker or owner), or commenting upon matters of public concern.

Clearly, that right belongs to the people — in our first amendment jurisprudence. As you can see (with just a casual glance around the place), my commentary touches on matters of significant public concern, and in doing so, makes liberal use of carefully-modified — but still plainly identifiable — corporate identity intellectual property. That is plainly my first amendment right. Thus, for 24 hours through this morning, this site carried the masthead banner at right, in solidarity — click to enlarge.

While I think the issue is largely decided, it is nice to know that no one will have to litigate the above issue, to establish this freeedom, for the rest of us — after yesterday. Per The New York Times, this morning:

. . . .Wednesday [1.18.12], this formidable old guard was forced to make way for the new as Web powerhouses backed by Internet activists rallied opposition to the legislation through Internet blackouts and cascading criticism, sending an unmistakable message to lawmakers grappling with new media issues: Don’t mess with the Internet.

As a result, the legislative battle over two once-obscure bills to combat the piracy of American movies, music, books and writing on the World Wide Web may prove to be a turning point for the way business is done in Washington. It represented a moment when the new economy rose up against the old.. . . .

Legislation that just weeks ago had overwhelming bipartisan support and had provoked little scrutiny generated a grass-roots coalition on the left and the right. Wikipedia made its English-language content unavailable, replaced with a warning: “Right now, the U.S. Congress is considering legislation that could fatally damage the free and open Internet.” Visitors to Reddit found the site offline in protest. Google’s home page was scarred by a black swatch that covered the search engine’s label.

Phone calls and e-mail messages poured in to Congressional offices against the Stop Online Piracy Act in the House and the Protect I.P. Act in the Senate. One by one, prominent backers of the bills dropped off. . . .

One ancillary point I’ve not seen others make yet is this:

After Citizens United (the Super-PAC-enabling Supreme Court decision) was handed-down, and corporations were effectively handed affirmative, full-fledged first amendment political influencing rights, a logical and necessary implication will be that the same corporations must now also live by the limits of the first amendment jurisprudence, as well: these very-public “people” (business entities) must fairly be subject to commentary and criticism, even couched as fact rather than opinion — without a right to complain at law — except in the limited circumstance of “actual malice” falsity, or “reckless disregard” factual errors.

Buckle-up, and pucker-up, ole’ Buttercup.

Mediation Scheduled — In Cobb v. Merck, A Federal ENHANCE ERISA Suit

It is becoming increasingly clear that New Merck no longer intends to fight it out (“. . .until the last dog is hung“), as to these now nearly four-year old allegations.

All of the federal court proceedings have been temporarily stayed as of January 11, 2012, in Cobb v. Merck, et al., a federal ERISA would-be class action, to allow for a February 13, 2012 mediation session. Cobb is a case echoing the earlier Gradone v. Schering-Plough, et al. claims — and thus pleading the ENHANCE disclosure delay facts, as ERISA violations. Cobb personally names Merck officers and directors as defendants (including Messrs. Clark, Kellogg and Frazier), while Gradone personally names legacy Schering-Plough ones, including Hassan, Bertolini, Cox, Sabatino and Becherer.

Recall that the legacy Schering-Plough version of this suit (Gradone), is now pending a final settlement order — in fact, on January 13^th, Judge Cavanaugh signed an order granting another 60 days to finish the paperwork on that agreement in principle — to settle the matter.

All of that said, I do think it a sign of emerging wisdom on Mr. Frazier’s part — that he no longer seeks to litigate these claims (recall his directly contrary stance, as General Counsel, on the Vioxx^® claims). First, in my estimation, there is arguable merit to each of them — and second, even if one believes there is not — it is high time to put the ENHANCE matter in Whitehouse Station’s rear-view mirror, and permanently so. Little might be gained, even in a complete victory, here — and each time a court date is scheduled, a rehash of the facts will likely run in the popular press. Just no longer worth it.

On an at least marginally-related note, Jami Rubin opined — in the form of a leading question, to Ken Frazier, about ten days ago, at the Goldman conference — that there could be no real stock upside to even a complete “win” in the IMPROVE-IT outcomes trial (see left side bar for background on that). While Mr. Frazier suggested that there might be some upside left, he also essentially conceded that anything short of a clear win would present new downside risk for the Vytorin^® franchise (now clocking about $3.8 billion in annual sales).

So it goes.

Goldman Keeps Merck At “Neutral”, With Current NYSE-Quoted Prices Around $38

Given that Chairman/CEO Frazier gave a very thoughtful, and yet candid presentation last week, it must be more than a little disappointing that Goldman kept its non-favored stance on the Whitehouse Station company:

. . . .Goldman, Sachs & Co. reiterates “Neutral” rating on Merck. . .

So it goes.

Merck Files Cain v. Hassan Settlement Notice With SEC

Just as I said it would, tonight (dumped into the memory hole, after-hours on the beginning of a long King Day holiday weekend), Whitehouse Station filed the notice of settlement for Cain v. Hassan — right here.

. . . .THE RIGHT TO APPEAR AND OBJECT

. . . .Any current New Merck shareholder who was a New Merck shareholder as of December 21, 2011 who objects to the Settlement, the judgment to be entered thereon, or the award of attorneys’ fees and expenses to Plaintiff’s Counsel, or who otherwise wishes to be heard, may appear in person or by his or her attorney at the Fairness Hearing and present any evidence or argument that may be proper and relevant, provided, however, that any shareholder who wishes to object or be heard must follow the following procedures: The shareholder must, by no later than February 8, 2012, file with the Court a written objection, stating all supporting bases and reasons for the objection, including the identification of all witnesses, documents or other evidence that are to be presented at the Fairness Hearing in connection with the objection and a summary of the substance of the testimony to be given by any such witnesses, and submit documentary evidence of the shareholder’s continuous ownership of New Merck common stock since December 21, 2011. This submission should be addressed as follows:

Clerk of the Court
United States District Court for the District of New Jersey
Martin Luther King, Jr. Federal Building and U.S. Courthouse
50 Walnut Street
Newark, New Jersey 07101. . . .

So it goes.