Merck

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Merck Co., Inc. RecommendationSell

• Yuqian(Annie) Zhang
• Nov. 4th, 2004

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Our position

• 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

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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.
• Product Therapeutic Category 2004 Net Sales
  
•  
• ZOCOR Cholesterol modifying 4.9 to 5.1
  billion
• FOSAMAX Osteoporosis 3.0 to 3.2 billion
• COZAAR / HYZAAR Hypertension 2.7 to 2.9
  billion
• Coxibs Arthritis and Pain 2.8 to 3.0
  billion
• (VIOXX and ARCOXIA)
• SINGULAIR Asthma and Seasonal Allergic Rhinitis
  2.4 to 2.7 billion
•  
• Source Merck Co. 04 Q2 release

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Pharmaceutical Industry overview

• Global sales of prescription (including both
  branded and generic drugs) and over-the-counter
  (OTC) remedies is around 300 billion annually.
• Many large US employers have seen a doubt digit
  annual increase in their employee health-care
  costs for the past more than five years.
• 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.
• The world's increasing aging population is
  another factor driving the industry.
• Focus on products for chronic rather than acute
  diseases. The world's two best-selling drugs,
  Merck's Zocor and Pfizer's Lipitor, both treat
  high cholesterol.
• Increasing MA in the industry.

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Pharmaceutical Industry Issues

• Pressures on sales growth
• 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
• Huge RD cost In 2003, the Pharmaceutical
  Research and Manufacturers of America member
  companies invested an estimated 33.2 billion,
  17.7 of domestic sales on RD.
• Increasing cost to handle legal issues.

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Pharmaceutical Index DRG vs. SP500 two years
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MRK vs. DRG two year
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Peer group- five year key ratios

•  

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Peer group- RD to Sales

• Merck kept a well below industry average RD to
  sales ratio from 1996 to 2003. Has struck 145
  deals, of which only 21 for products.
• 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.
• Eli Lilly RD 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.

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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.
• 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.
• 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.
• 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.
• Oct. 11, 2004, began a search to replace CEO
  Raymond Gilmartin.
• 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

Vioxx sales
EBIT margin
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
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Sensitivity analysis-scenario one
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Sensitivity analysis-scenario two
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Sensitivity analysis- scenario three
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Recommendation Sell

• Short to medium term
• Voixx withdrawal hurts sales cash flow
• Potential litigation cost will hurt profit cash
  flow
• Management uncertainty
• Long term
• 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

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QA