Merck Research
(Fortune)---Rat No. 3 is determined. He
lumbers straight to an
octagon in the corner of the pen and runs his white whiskers over
its edges. In another corner is a white ball. It holds little
interest for
No. 3--exactly the result Merck researcher
for. The rat has a few micrograms of Merck's memory-enhancing
compound coursing through its tiny veins, a prototype medicine
that might someday treat Alzheimer's patients or people who have
suffered a stroke. How does
Rats can only remember what's happened to
them in the past four
hours. No. 3 spends more time investigating the octagon, says
he's bored with it.
The medicine
Park labs just outside
work and clinical trials to go before the company can send it to the
FDA for
approval. The odds that any test compound will make
it to
market are incredibly low. It's a fact
painfully aware of. At 29, and at the beginning of her career with
Merck,
pharmacists' shelves before she retires. Even so, she is excited by
her findings. "It's so novel we can't really talk about it
right now,"
says
memory into that of a 50-year-old."
Unfortunately, Merck investors don't need a
pill to remember
happier times. Back in 2000, the
behemoth's revenue growth was tops in the drug industry.
Between 1994, when
Merck's annual earnings growth averaged
17%; in the 1990s,
Merck's shares rose 600%. But those days
have faded. Following
a raft of patent expirations on some of Merck's biggest drugs,
the
$48-billion-a-year company will have no
earnings growth at all in
2002. Since December 2000, the stock has
fallen 43%, vs. 21% for
the S&P; Merck shares recently traded for $53 each.
What's odd about Merck's predicament is
that its scientists have
been demonstrably more innovative than the competition. Since
1996, Merck researchers have patented 1,933
new compounds,
400 more than
second-place Pharmacia. Certainly not all newly
discovered compounds lead to viable products, but patents are a
prime indicator of research productivity. Even more impressive,
Merck's scientists do more with less. Their
discoveries cost an
average of $6 million per patent, the lowest in the industry.
Competitors like Pfizer,
drug revenues back into R&D, while Merck reinvests just
12%.
Exceptional science is nothing new for
Merck. The company traces
its roots to 1668, the year
Merck was the most powerful drug firm on
the Continent, the first
to commercially produce morphine, codeine, and cocaine, then
considered medicinal. Thirty years later scion
crossed the
N.J., where
the company still maintains a research facility. In the
1930s, Merck led the industry in
synthesizing vitamins like B-1 and
B-12, and in 1949 it worked with Nobel
Prize-winning biochemists
batch of arthritis-reliever cortisone.
That focus on breakthrough medicine is the
main reason Merck
continues to attract the world's leading biochemists and engineers--
people like
confines of academia to join Merck as executive vice president of
neuroscience. "I was having a ball in
came here because Merck enjoys a widespread reputation for
sustained application of the best science," says Choi.
Does he feel
pressure to produce a big drug? Sure he does. "But this is a
singular moment in medical history,'' he says. "Things are
definitely
going to happen."
The question is when. Despite the company's
edge in innovation
and efficiency, Merck hasn't been able to churn out enough new
products to offset shrinking sales from drugs losing patent
protection. The malaise isn't unique to Merck, of course. Beset by
cutthroat competition from generic drugmakers,
pricing constraints
imposed by managed care, threats of government price regulation,
and more intense FDA scrutiny, most brand-name drugmakers
are
struggling. Merck's problems are complicated by its decision last
winter to spin off Medco, the
prescription-benefits-management
firm that provided more than half of Merck's revenues. As a result,
the company's future depends more than ever on blockbuster
drugs--at a time when the entire pharmaceuticals industry is having
difficulty delivering them.
That's been the case for a while now.
During the 1990s only 15%
of the 1,035 major drugs approved by the FDA used new active
ingredients or treated illnesses in original ways. The majority of
approvals were modifications of existing medicines, so-called me-
too drugs. Even without much innovation, the cost of ushering a
new medicine to market has risen 60% since 1990, to more than
$800 million.
In this difficult environment, a drugmaker's pipeline of soon-to-be-
released medicines is critical. Patents give companies exclusive
sales rights for an average of 11 to 12 years, but once that period
expires, generic drugmakers enter the market
and begin selling the
medicine at cut-rate prices. Within a month or two the name-brand
company can lose as much as 80% of its sales to generic
replacements. In order to stanch that revenue drain, name-brand
companies must generate a constant flow of new products. Yet
their pipelines are just about tapped out.
No company illustrates Big Pharma's woes better than Merck. Last
month the patent on its $1.1 billion Prinivil
ran out, ending a spate
of recent expirations that included Mevacor,
Vaseretic, and Pepcid-
-together representing annual sales of
roughly $4.5 billion, or 10%
of Merck's total. Another potential weak spot is Merck's Prilosec, a
heartburn remedy developed in a joint venture with AstraZeneca
PLC. The world's second-bestselling drug, Prilosec
garners $3
billion a year in
FDA has just awarded a generic maker the
right to market a form
of the drug. Merck and AstraZeneca are
fighting to extend the
patent.
When Merck executives talk about promising
new drugs, they point
to Arcoxia, an arthritis pain reliever; Zetia, a cholesterol medicine;
and something the company calls Substance P, a drug to prevent
nausea and vomiting in chemotherapy patients. The company is
loath to mention, though, that it pulled its FDA application for
Arcoxia last spring for additional review, and
that Substance P has
run into snags in clinical testing. The release dates for both have
been pushed back. Even so, Merck claims its pipeline beyond
those drugs is among the strongest ever, with future medicines like
a diabetes drug called KRP297, a human papilloma
virus vaccine,
and an HIV vaccine that is in phase I of clinical testing.
Wall Street isn't convinced. Says
growth? No. Until we see proof, there's going to be
skepticism."
The disbelief sounds awfully familiar to
Merck's old guard.
Scolnick joined the company in 1982 as a research scientist and
achieved a place in the Merck pantheon when he led the team that
developed the cholesterol reducer Mevacor in
the mid-1980s. Now
executive vice president of science and technology, he's seen
Merck endure many feast/famine cycles.
"We went through the
same stuff in '94 and '95," Scolnick
says. "I don't think most
analysts get it. We told them about Fosamax, Singulair, and
Cozaar. They didn't think these drugs would be
big. They said we
had no pipeline." Those drugs, it turns out, are three of
Merck's
biggest sellers. Scolnick adds: "We know
what we have, and we
feel pretty confident. Understate and overperform--that's
how I was
brought up in science."
texture to his soft-spoken words. He's already used two sheets of
paper to illustrate the lay of the land in the drug industry, but
now,
in his private meeting room, he pulls the yellow pad closer to the
edge of the table and draws a bold black line from the top left-hand
corner of the page to the bottom right. That dark downward stroke
symbolizes 2001 sales of Merck's osteoarthritis drug, Vioxx,
he
says, and helps explain the company's no-growth fix. Three years
ago Merck introduced Vioxx, expecting it
to hit big--and it did. But
just as Vioxx was entering its second year
of sales in August 2001,
the Journal of the American Medical Association published a report
that questioned whether Vioxx and drugs
like it could be linked to
heart attacks. Sales dipped immediately. "It was a one-time,
unexpected event," says Gilmartin. Slowing Vioxx sales, he says,
were the principal reason he was forced to revise the company's
earnings forecast for the year.
Critics say Gilmartin
could have done more to warn shareholders
about the current bust cycle. In fact, Wall Street worried that Merck
would have a difficult transition during its patent expirations, but
Gilmartin was adamant that the company would maintain
competitive earnings growth. "He committed to something the
market didn't think was possible, and the market was right," says
shareholder perspective, Gilmartin doesn't seem
to acknowledge
that as a failure. Therefore, people are skeptical of their
abilities
going forward." Gilmartin invokes a
baseball analogy to explain
why Wall Street shouldn't give up on his company. "It's like
having
a hitter with a great record who's in a slump but who will
produce in
the future. We just have to keep slugging it out." Says
Lewent: "If you strip away the dampening effect of the patent
expirations, what you have left is a core business that's doing very
well. We have the ability to rebound."
As if Gilmartin
didn't have enough to worry about, he is preparing
to spin off Medco Health Solutions,
Merck's prescription benefits
management (PBM) arm. In an IPO scheduled for the last week of
plans to distribute the remaining portion to Merck shareholders
over the subsequent 12 months.
The divestiture will spell big changes for
the drugmaker. Once the
separation is complete, Merck will drop from the No. 1 spot in the
global pharmaceuticals business to No. 4 (behind
purchased Medco in 1993 to hedge its bets
against what everyone
thought would be a more heavily regulated, Clinton-influenced
health-care environment. Its competitors followed suit, buying or
creating their own benefits management programs. But by the late
'90s, Merck was the only major drug firm
still in the PBM business.
With Medco, the drugmaker thought it had an edge. Merck's
smaller-than-average sales force could focus mostly on selling to
managed-care operations rather than to doctors, winning millions
of customers at a time. The strategy appeared to work. In less
than
ten years, Medco's revenues grew from
$2.2 billion to $26 billion in
2001,
accounting for 54% of Merck's overall sales.
But it was hardly a match made in heaven.
For one thing,
managing prescription benefits is far less lucrative than developing
and selling drugs--last year Medco
accounted for less than 10% of
Merck's
profits. Worse, Medco's
return on capital was much lower
than that of the drug business. On top of that, Medco
is saddled
with antitrust suits and federal investigations as a result of its
ties
to Merck. Plaintiffs in the cases allege that Medco
steers patients
toward more expensive Merck-made drugs instead of cheaper
remedies made by competitors. Merck executives say the cases
have no merit and deny any wrongdoing. They also claim the legal
troubles have little to do with Medco's
sale.
In all, Merck executives refuse to call the
Merck-Medco pairing a
failure. It was, they say, a timely idea whose time has passed.
Surely, though, Medco
never really delivered on its promise,
mostly because the
really want to go back to focusing exclusively on pharmaceuticals.''
In anticipation of the breakup, Gilmartin is beefing up Merck's sales
force, adding 500 salespeople this year.
So it's up to the labs. But as Merck knows
all too well, discovering
drugs isn't like dreaming up a tasty new soft drink or tweaking next
fall's line of SUVs; it's an unpredictable, tedious endeavor.
Breakthroughs happen in their own time. As
a Merck biochemist
puts it, "What we do is look down a lot of blind alleys to make
sure
they're really blind alleys."
Gilmartin, for his part, is putting his money where his mouth is,
infusing Merck's R&D with a $2.9 billion investment, an 18%
increase over 2001's budget. The extra funds will go toward things
like the anti-obesity drug the company is developing at its San
Diego labs. Still in the earliest phases of testing, the drug seeks to
tap into the portion of the brain that regulates appetite.
"We're
looking at solving this problem not through the gut but
neurologically," says
of research.
work. He's intrigued, he says, by the sheer "elegance" of
Merck's
sought-after solution. Similar products attempt to attack obesity by
fighting fat molecules in the digestive tract, but they come with
terrible side effects like intestinal leakage. "Those products are
fine--if you like wearing diapers," sniffs
Merck is also on the hunt for an
anti-anxiety drug that doesn't carry
side effects like sexual dysfunction and nausea. And the company
has entered into scores of joint ventures and licensing deals with
biotechnology firms--involving everything from rotavirus vaccines
to gene mapping. To make these discoveries and others, argues
events at work here. The degree to which we're successful is
dependent on the quality of our researchers. Our strategy can fail
only if we have mediocre players."
Merck she published several acclaimed
papers on brain activity
and learning in rats. And though they will never know it, rat No. 3
and the other denizens of her memory lab could play a small but
important role in Merck's future.