Merck & Co., Inc.
Recommendation
Sell
Yuqian(Annie) Zhang
Nov. 4th, 2004
Our position
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Own 300 shares
Purchased at $70.5 on Dec. 2nd, 1999
9.4% of the portfolio (cost)
Closed at $27.87on Nov.3rd, 2004
The loss up to -$12,793.26 (-60.48%)
2.7% of the portfolio (market value)
Present P/E: 9.39
Present EPS: 2.97
Market Cap: 61.84B
Company profile
A global research-driven pharmaceutical products company with history back to
1887
 Ranked 83 in Fortune 500, 15 in FT Global 500
 Operations in the United States, Europe, Middle East, Africa and Japan with
63,200 employee
 59% of sales came from the US vs. 41% outside the US in 2003.
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Product
Therapeutic Category
2004 Net Sales
ZOCOR
Cholesterol modifying
FOSAMAX
Osteoporosis
COZAAR / HYZAAR Hypertension
Coxibs
Arthritis and Pain
(VIOXX and ARCOXIA)
$4.9 to $5.1 billion
$3.0 to $3.2 billion
$2.7 to $2.9 billion
$2.8 to $3.0 billion
SINGULAIR
$2.4 to $2.7 billion
Asthma and Seasonal Allergic Rhinitis
Source: Merck &Co. 04 Q2 release
Pharmaceutical Industry overview
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Global sales of prescription (including both branded and generic drugs) and
over-the-counter (OTC) remedies is around $300 billion annually.
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Many large US employers have seen a doubt digit annual increase in their
employee health-care costs for the past more than five years.
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Traditional top three markets are the US, Western Europe and Japan, while the
rising living standards in other regions/countries increase the demand for better
health care and sophisticated drugs.
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The world's increasing aging population is another factor driving the industry.
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Focus on products for chronic rather than acute diseases. The world's two bestselling drugs, Merck's Zocor and Pfizer's Lipitor, both treat high cholesterol.
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Increasing M&A in the industry.
Pharmaceutical Industry Issues
Pressures on sales growth:
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Aging population requires cheaper drugs.
Impact from imported prescription drugs.
Impact from any change of corporate health-care budget.
Increasing patent expiration issues.
Impact from any change of FDA policies.
Pressures on profit as well as cash flow:
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Huge R&D cost: In 2003, the Pharmaceutical Research and
Manufacturers of America member companies invested an
estimated $33.2 billion, 17.7 % of domestic sales on R&D.
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Increasing cost to handle legal issues.
Pharmaceutical Index DRG vs. SP500 –two years
MRK vs. DRG two year
Peer group- five year key ratios
Profitability
ROIC
40.00
30.00
Merk
20.00
Pfizer
10.00
Eli Lilly
0.00
12/31/03 12/31/02 12/31/01 12/31/00 12/31/99
Leverage
Debt to Equity
80.00
60.00
Merk
40.00
Pfizer
20.00
Eli Lilly
0.00
12/31/03 12/31/02 12/31/01 12/31/00 12/31/99
Liquidity
Quick ratio
1.50
Merk
1.00
Pfizer
0.50
Eli Lilly
0.00
12/31/03 12/31/02 12/31/01 12/31/00 12/31/99
Peer group- R&D to Sales
100,000
10,000
1,000
100
10
1
Merck
Pfizer
Eli Lilly
Sales ($M)
22,486
45,188
12,583
R&D to sales
14.13%
15.56%
18.70%
40.00%
36.00%
32.00%
28.00%
24.00%
20.00%
16.00%
12.00%
8.00%
4.00%
0.00%
Sales ($M)
R&D to sales
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Merck: kept a well below industry average R&D to sales ratio from 1996 to 2003. Has
struck 145 deals, of which only 21 for products.
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Pfizer: the world's largest pharmaceutical research effort with more than 13,000
scientists supported by $7.1 B in 2003; pipeline includes 234 deals, of which 63 for
products.
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Eli Lilly: R&D to sales at the top of industry; has launched five new products in past 15
months; pipeline includes 130 deals, of which 49 for products.
Merck Issues Update
According to SG Cowen brokerage, a frightening 29% of 2003 revenue at risk due
to product patents expiring between 2004 and 2008, vs. 16% among the Big
Pharmaceutical companies.
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In Feb., Apr. and Aug. 2003, discontinued three phase I or II clinical trails; In Nov.
2003, discontinued two phase III clinical drug development program for treatment of
depression and diabetes.
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Sept. 30, 2004, announced the withdrawal of Vioxx, share closed down $12.07,
nearly 27 percent, to $33, resulting in market capitalization loss $26 billion.
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A.G. Edwards analyst predicted that FDA may want 18-month safety studies like
they wanted for Vioxx for the successor to Vioxx, Cox-2 inhibitor Arcoxia.
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Oct. 11, 2004, began a search to replace CEO Raymond Gilmartin.
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Nov 1, 2004, share price plunged more than 10 percent, after a media report said
that documents show Merck hid or denied evidence for years. Law suit cost is
estimated up to 12B.
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Valuation -DCF
Sales
growth
4.85%
Vioxx
sales
EBIT
margin
2004
2003
40.25%
2005
2006
2007
2008
4.00%
3.50%
3.00%
3.00%
3.00%
(1,250)
(2,588)
(2,665)
(2,745)
(2,827)
36.00%
33.00%
30.00%
30.00%
30.00%
Discount rate
7.77
8.46
9.16
Target price(constant growth)
48.1
41.9
37.1
Target price (P/E)
39.1
35.8
32.6
Sensitivity analysis-scenario one
Litigation cost hurts EBIT in S-T
WACC
EBIT in 2004 &
05, $ billions
0
10
12
14
7.77
8.46
9.16
48.1
45.0
44.4
43.8
41.9
38.9
38.3
37.6
37.1
34.0
33.5
32.3
Sensitivity analysis-scenario two
Generic competition hurts EBIT in L-T
EBIT margin after
2006
30%
27%
24%
21%
18%
15%
7.77
WACC
8.46
9.16
48.1
43.9
39.8
35.7
31.6
27.4
41.9
38.3
34.8
31.2
27.6
24.0
37.1
33.9
30.8
27.7
24.5
21.4
Sensitivity analysis- scenario three
Lack of breakthrough products in L-T
Constant
grow th
3%
2%
1%
0%
-1%
-2%
7.77
WACC
8.46
9.16
48.1
40.8
35.7
31.9
28.9
26.7
41.9
36.4
32.3
29.2
26.8
24.8
37.1
32.8
29.5
26.9
24.9
23.2
Recommendation: Sell
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Short to medium term
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Voixx withdrawal hurts sales & cash flow
Potential litigation cost will hurt profit & cash flow
Management uncertainty
Long term
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Long term growth will decrease due to the lack
of pipelines
Long term profit will shrink due to increasing
generic competition
Industry uncertainty
Competition from peer group
Q&A