Merck preaches the value of 'focus' as it spins off $6.5B women's health, biosimilars units

If one word could sum up Merck & Co.’s fourth-quarter earnings report, which included an announcement of a planned spinoff of its women’s health and biosimilar businesses, it would be “focus.”

Merck CEO Ken Frazier repeated the word several times during a conference call with analysts, as did other top executives, including Kevin Ali, the longtime insider appointed CEO of the yet-to-be-named new company.

After considering a spinoff for the past few years, Frazier said, Merck decided now is the right time to separate women’s health and biosimilars from the main company. The new company will also preside over legacy brands in dermatology, pain and respiratory diseases, as well as some cardiovascular mainstays, including Zetia and Vytorin.

The to-be-spun-off business is expected to bring in $6.5 billion in revenues this year, the company said, and the transaction should be completed in the first half of next year.

Why now? When an analyst asked Frazier that question at the start of the Q&A session during the call, he returned to the theme of focus.

“This is about taking actions today that will ensure the long-term growth and viability of Merck,” Frazier said. Back when the company first considered a spinoff, legacy products were throwing off needed cash to prop up the growing oncology business, he explained. Thanks largely to immuno-oncology blockbuster Keytruda, that business has become an unqualified success.

“That success has been due to our ability to allocate capital to a business we didn’t have before,” Frazier said, “and getting the entire organization focused and aligned around an opportunity that we had around Keytruda and other compounds behind Keytruda.”

But the spinoff's financial return was also an important consideration, executives said. Merck should achieve more than $1.5 billion in operating efficiencies by 2024 and a non-GAAP operating margin of more than 40%. Merck also expects to reap $8 billion to $9 billion from the expansion, which it could use for business development or share repurchases, they said.

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Still, some analysts struggled with potential risks the spinoff could present. “The bull/bear on this deal will likely center around a strong growth profile and more innovative business against an initial earnings step-down … and now more concentration around Keytruda,” said RBC Capital Markets analyst Randall Stanicky in a note to investors. He added that any initial hit to earnings would likely be a short-term phenomenon.

The focus on Keytruda, however, could be more of a nagging problem, several analysts pointed out during the conference call. Frazier and colleagues said the spinoff would allow Merck to devote resources to a diverse oncology pipeline, but both the pipeline and the top line are still heavily reliant on Keytruda—and that worries the Street.

In the most recent quarter, Keytruda sales jumped 46% to $3.1 billion, but that was lower than what analysts had expected. Overall fourth-quarter sales rose 8% to $11.87 billion, which fell short of analysts’ consensus estimate of $11.98 billion. Adjusted earnings per share jumped 12% to $1.16, just nudging past the consensus estimate of $1.15.

Frazier said during the conference call that he’s mindful of the risk that the pared-down company would be overly reliant on Keytruda, but that there would be “benefits of our focus, both in terms of R&D and commercial execution going forward.” Merck’s oncology portfolio also includes Lenvima and Lynparza, he pointed out, plus 20 compounds in the pipeline: “We have more than Keytruda.”

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Lynparza, which Merck is developing with AstraZeneca, has scored some important wins of late, including priority-review designations from the FDA in prostate cancer and for an Avastin combo in ovarian cancer.

Roger Perlmutter, M.D., Ph.D., Merck’s VP of research, also lauded the company’s newfound focus, though he used slightly different terminology to describe it.

“I begin with a deep belief in the power of simplification to enhance productivity," Perlmutter said. "My colleagues and I have important objectives over the next few years that will result in improved treatments for malignant disease and heart failure, and provide vaccines that reduce suffering from infectious diseases. Simplification of our corporate structure can only sharpen on our focus on these critically important programs.”

Perhaps, but when analysts asked Perlmutter to provide details about the long-term pipeline beyond Keytruda, he was somewhat vague. “We have a lot of other interesting things going on” in heart disease and vaccines, he said. “There will be a lot of data coming forward in 2020.”

As for the Merck spinoff, it will be guided by Ali, whose experience includes serving as president of MSD International and of the company’s emerging markets unit. The NewCo’s board will be helmed by Carrie Cox, former CEO of Humacyte and chairman of Array BioPharma.

Merck’s top leaders said they believe the company’s revenue potential has been under-appreciated by Wall Street for some time. So far, the planned spinoff doesn’t seem to be changing that pessimistic sentiment. Merck’s stock fell nearly 4% in early trading Wednesday to $85.