Analyst gives Merck tough love

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Merck's R&D chief Roger Perlmutter's goal of transforming Merck—mentioned in June, again at its July 30 earnings call, and felt with the August 7 news that the previously announced manufacturing layoffs in Kenilworth, NJ were a go—have been noted, but Leerink Swann analyst Seamus Fernandez wrote in a Monday research note that he'd like to see more. Fernandez writes that what the company needs is not just a restructuring, which he says is inevitable, but a “deep restructuring” that will balance out a “lackluster 2013 top-line performance, disappointing Phase III/registrational pipeline evolution” and general industry challenges.

Fernandez writes that the company's turnaround should include trimming costs, and urges the drug maker to hew more closely to the industry spend of R&D accounting for around 14% of sales.

He also hits on the year's second-half buzz word: break-up. In this case the Leerink Swann analyst writes that shareholder prospects will remain limited unless Merck make significant cost cutbacks or provides “an updated plan to spin out or sell the highly attractive animal health business.” He also writes Merck could consider selling or finding a partner for its “sub-scale consumer business.”

The call to action sounds very much like what's going on with industry peers Novartis and Pfizer. Like Perlmutter who came on to transform Merck's R&D stance, Novartis's new CEO Joerg Reinhardt has told the Street that he is intent on changing his company. Reinhardt has said that this means ignoring categories the company does not dominate, not just shifting lines of scientific exploration, which means its vaccines and consumer businesses could be on the block.

Pfizer, meanwhile, recently deepened its flirtation with splitting up its businesses. The company has teased investors with the possibility of a breakup for some time, but made a decisive move in July to create hard divisions among its respective businesses so it can begin crunching numbers to determine the financial viability of each unit. The company said it expects to make a decision in 2017.

Merck's current strategic moves have been opaque—Perlmutter said in July that the company will “narrow our focus.” He also told investors that he has made the company's structure flatter and more efficient, but that has been about as definitive as this internal overhaul has been. He also told Goldman Sachs analyst Jami Rubin that he did not expect “big, enormous changes.”

The company has started to trim its R&D and SG&A spend, with R&D for the second quarter lagging $140 million behind Q2 2012, and SG&A coming in $60 million shy for spending in that same period.

The list of recent pipeline grievances includes the company's failure to win the FDA's approval for its sleep drug Suvorexant, delaying its submitting its osteoporosis medication odanacatib until 2014, and having an FDA Panel skip out on reviewing its anti-muscular relaxant Bridion (sugammadex). Delaying odanacatib over a need for additional data, triggered calls to overhaul management. Perlmutter replaced then R&D head Peter Kim four months later.

Ho-hum pipeline results are not the only thing capturing Fernandez's attention: the analyst writes that analysts do have hope for the company, namely its immune-oncology business. He writes that the drug maker's experimental PD-1 cancer drug Lambrolizumab looks like it has an edge over competitors from Bristol-Myers Squibb, Roche and AstraZeneca.

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