Keytruda keeps fueling Merck’s run, but CEO Frazier not ‘comfortable’ with future growth prospects

Merck's oncology portfolio, led by Keytruda, continues to drive sales, but Wall Street wants to see more diversification from the company. (Merck)

Merck & Co.’s oncology multitasker Keytruda has been such a huge hit that it has singlehandedly changed Wall Street’s expectations for the company. Now, they're set so high, it's tougher for CEO Ken Frazier and colleagues to meet, let alone beat estimates.

Frazier himself conceded Thursday that Merck needs to look beyond oncology to drive future growth, after reporting third-quarter numbers that fell short.

Keytruda came in slightly below expectations, at $1.89 billion for the quarter, and overall sales fell short, too. The company reported total revenues of $10.79 billion, up 4.5% year over year, but analysts had been expecting closer to $10.9 billion.

So it was no surprise that the tone of the report—and the analyst call following it—centered on Merck’s plans for dealmaking. One analyst noted that Frazier and his fellow executives brought up the topic at least a half-dozen times in their introductory remarks. Frazier was frank in his response to that observation.

“Let me start by saying that we’re pleased with the way in which our business is growing now, particularly in the oncology field, but that doesn’t make us comfortable,” Frazier said. “At the end of the day, we know that we have to continue to build our portfolio and build on our pipeline, and that’s why [business development] is an important priority for us going forward.”

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Keytruda sales were up a whopping 80% year-over-year during the quarter, with its newly partnered Lynparza and Lenvima also kicking in to drive strong oncology performance. And the company is set to haul in even more from its cancer portfolio as Keytruda racks up clinical trial wins in a variety of cancers. Last week, the company rolled out positive trial results in kidney cancer for a duo of Keytruda and Pfizer’s tyrosine kinase inhibitor Inlyta.

Then, at the closely watched European Society for Medical Oncology annual meeting earlier this week, Merck unveiled data showing Lynparza, which it shares with AstraZeneca under an $8.5 billion deal forged last year, reduced the risk of disease progression or death by 70% in BRCA-mutated ovarian cancer.

So what exactly does Merck’s business development strategy entail? Frazier was short on details, much to the chagrin of some analysts.

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Besides growing its oncology pipeline, the company is looking for ways to boost its other big businesses, including animal health and vaccines.“Although we remain disciplined in our approach, we’re also committed to acquiring assets that will create value,” Frazier said. The company has the capacity to do deals “of all sizes and all types, the question is are they the right deal for Merck?”

During the call, Frazier was asked more than once if Merck’s deal strategy might involve selling or spinning off its animal health unit—a timely query, considering Pfizer’s successful carve-out of Zoetis and Eli Lilly’s more recent Elanco spinoff, not to mention speculation that Bayer might offload its veterinary unit.

Goldman Sachs analyst Jami Rubin went so far as to tell Frazier during the conference call that she estimates the animal health business offers a $12 per share upside “if the market were to value your animal health business in line with Zoetis and Elanco, both of which have been hugely successful.” She wondered what steps the company would take to highlight animal health's value to Merck, and whether Frazier—who has long championed keeping that business in-house—might change his mind and consider spinning it off after all.

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Frazier said Merck actively evaluates its portfolio on an ongoing basis, but that Merck shares “the market’s excitement around animal health’s value as a sector, and our business in particular. In fact, we believe we run this business very well inside the company, compared to its competitors,” Frazier said.

Even without getting details on Merck’s business development strategy, other analysts on the call worried whether ongoing threats of government reform—including the possibility that some products covered under Medicare Part B would be shifted to Part D—might hamper reimbursement for some key products, making it difficult to choose assets to add to the pipeline.

Adam Schechter, Merck’s president of Global Human Health, said he’s not worried, because Merck’s strategy is to focus on developing products that meet unmet medical needs in unique ways. If the company finds drugs that will make a “significant difference in the world” and that aren’t copycats, “the U.S. will continue to have good reimbursement for those types of products,” he said. “So when we’re looking for business development, we’re looking for real breakthroughs that can increase the health of large numbers of patients.”

Merck’s earnings report came just hours before Donald Trump’s much anticipated speech on drug prices, and one analyst noted that the president had commented in the past on the disconnect between how Keytruda is priced in the U.S. vs. other countries.

Frazier said he needs to hear more from Trump before he can determine how government action might affect Merck. The company “would be opposed to anything that would actually create a problem from the standpoint of patient access to innovation,” Frazier said. “But we really need to see further detail to better understand how all this is expected to be implemented.”