Merck's Big Bet on Research By Its Scientists Comes Up Short
As 4 of 11 Drugs in Pipeline Fail, Some Investors Clamor
For Merger or New Strategy
By PETER LANDERS and JOANN S. LUBLIN
Staff Reporters of THE WALL STREET JOURNAL
For years, as the drug industry was transformed by a wave of new hardball tactics, Merck & Co. stayed above the fray. Other companies rushed together in megamergers. Merck remained proudly independent. The others spent millions aggressively marketing new products that were only marginally different from old ones. Merck emphasized one-of-a-kind drugs. And while other companies stuffed their product lines with drugs they licensed from smaller companies, Merck insisted it could find plenty of medicines on its own.
It made, in short, a huge bet on its own scientists. "This is the most productive time ever for Merck research," Chief Executive Raymond Gilmartin boasted in Merck's 2001 annual report. Last year, he said he expected Merck to either start selling or seek approval for 11 medicines by 2006.
Now Mr. Gilmartin's bet has come up short. Four of those 11 medicines have already failed, including ambitious treatments for depression and diabetes that were cancelled this month. Two others have been delayed. Merck's profits, already falling slightly, are in danger of a sharp decline when its big-selling anticholesterol drug, Zocor, loses U.S. patent protection in 2006.
Merck faces the classic dilemma of a corporation whose business model has failed to produce results. It could stick to the model, insisting that its scientists are just going through a dry spell. But that leaves it with little to reassure investors who want profit growth now, not several years down the road. Or, Merck could try to copy its competitors with a flurry of deal-making and me-too drugs. That's hard too, because many of the best deals are gone, and the company's research culture can't change overnight.
Mr. Gilmartin, who has often pointed with pride to Merck's differences from other companies, says his course over the past years has been the correct one and he is determined to stick with it. He calls the research disappointments "bad luck" rather than a sign of fundamental problems. "We've got a distinguished record of developing medicines that are novel ... and we continue to pursue that strategy," he said in an interview Wednesday.
Merck's board appears to agree. The board met Tuesday at Merck's headquarters in Whitehouse Station, N.J., for a regular session and grilled research chief Peter Kim about the failure of the depression and diabetes drugs, both of which were in large human trials, one person familiar with the meeting says. But the board didn't call for any major changes of strategy and continues to back Mr. Gilmartin, who has led the company since 1994, say three people familiar with the board's thinking.
During this week's meeting, Merck board members also reviewed efforts to groom potential internal successors for Mr. Gilmartin, 62 years old. One industry recruiter reports being rebuffed in recent approaches to several board members about the possibility of launching an external hunt for Merck's next CEO. The efforts all came back with the same message from board members: "We're not replacing Ray," the recruiter says.
Mr. Gilmartin has long planned to step down when he reaches Merck's mandatory retirement age of 65 in March 2006. "That schedule hasn't changed," says a person familiar with the board's thinking. Directors "are going to arrange a very smooth and orderly transition," this person says.
Investors have made clear their displeasure with Mr. Gilmartin. The stock price of Merck, one of the 30 components of the Dow Jones Industrial Average, is down 30% since its recent peak in June even as other major drug stocks are up slightly. Many analysts and investors are calling on the board to replace Mr. Gilmartin with someone who will shake up the company -- even at the risk of altering Merck's culture. One possibility often mentioned is a merger with Schering-Plough Corp. Merck and Schering-Plough already cooperate in selling an anticholesterol pill, and Schering-Plough's chief executive, Fred Hassan, who is 58 years old, is seen as a candidate for the top post in the event of a merger.
Mr. Gilmartin said he continues to be opposed to mergers. Mr. Hassan said in an interview on Nov. 18 that he is open to the idea of a merger with Merck or another large company but only after Schering-Plough's fortunes have fully recovered from the loss of its patent protection on allergy drug Claritin, which he doesn't expect to happen until at least 2005.
Some observers think Merck is right to stick to its guns. "If they change strategy now, it would be a huge mistake," says Gary Stibel, a veteran consultant who advises some of Merck's rivals. "The fact that they've missed some free throws doesn't mean they should start throwing them underhand." Mr. Stibel says he's adding to his own holdings of Merck shares because of his confidence in its research.
At stake is the future of a company often regarded as a paragon of American science. For more than 50 years, Merck has prided itself on being above the hurly-burly of everyday profit-seeking. "We try never to forget that medicine is for the people. It is not for the profits. The profits follow, and if we have remembered that, they have never failed to appear," were the words of longtime President George W. Merck in a 1952 Time magazine interview, which Mr. Gilmartin still cites in his speeches.
Although rivals sniped at what they considered Merck's holier-than-thou attitude, the company backed up its words with innovation over the decades. From the age of penicillin (which Merck was a leader in manufacturing) to the modern era of cholesterol-lowering statins (Merck sold the first one), the company has consistently led the industry in bringing new medicines to the market.
In the late 1980s and 1990s, Merck rode the emerging science of heart disease to new heights, selling drugs for high cholesterol and high blood pressure that were proved to reduce risk in studies of tens of thousands of patients. Merck's idea of profiting from scientific discovery was the industry model. Others followed suit in different diseases, creating entirely new multibillion-dollar classes of medicines such as the group of antidepressants led by Eli Lilly & Co.'s Prozac and the proton pump inhibitors for heartburn.
By the time Roy Vagelos, a revered cell biologist, stepped down as Merck's chief executive in 1994, many believed the biggest threat to growth would be the managed-care revolution. The widespread fear: Aggressive insurers would force drug makers to offer deep discounts in exchange for getting on approved drug lists. Merck's board chose Mr. Gilmartin, a former electrical engineer who was chief executive of medical-device maker Becton, Dickinson & Co., in part because it thought his experience dealing with big customers would be helpful in negotiating with HMOs. Mr. Gilmartin, the genial son of a construction superintendent, also put a more gentle face on a controversial industry.
The managed-care threat proved to be a mirage. Americans wanted their drugs and weren't about to let HMOs push them around. On the contrary, managed care turned out to be a conduit for drugs to patients as health plans began to be rated on how well they treated patients with chronic conditions -- including blood pressure and high cholesterol.
The real threat to drug companies was entirely different: the difficulty coming up with successors to the older blockbusters, which, as the result of a 1984 law, faced generic competition when their patents ran out.
One solution was the megamerger. Three of the top pharmaceutical companies today -- Pfizer Inc., GlaxoSmithKline PLC and Novartis AG -- are all merger products. Typically the merged company has kept most of the revenue of the original companies while slashing overhead costs. The result is higher profits even without new products.
Mr. Gilmartin shunned mergers, saying they would distract Merck from its mission of finding innovative medicines. He also believed that Merck could expand its profits through new products rather than merger-driven cost cuts.
Most pharmaceutical giants have also been aggressive in pursuing smaller companies with good drugs in development, such as U.S. biotechnology firms and little-known European and Japanese companies. Pfizer, for example, picked up rights to the allergy blockbuster Zyrtec from Belgium's UCB SA. Johnson & Johnson bought biotechnology firm Centocor in 1999 and got full U.S. rights to the rheumatoid arthritis treatment Remicade.
Lastly, the marketing war has heated up, often over drugs that differ little in patient benefit. Schering-Plough, for example, heavily advertises the prescription allergy pill Clarinex, which is almost identical to its earlier pill Claritin. Clarinex costs more than $2 a pill, whereas some generic versions of Claritin cost around 25 cents a pill.
Merck's abandoned depression drug, known generically as aprepitant, epitomizes the way the company set itself apart from rivals. Instead of working on serotonin, aprepitant blocks the flow of a mysterious brain chemical called substance P that Merck scientists were convinced had something to do with depression. If it had worked, it might have offered hope for millions who weren't helped by Prozac and its cousins or suffered from side effects.
Merck poured more than a decade of effort into testing aprepitant, bulling ahead even after one trial showed it didn't work. But when it unsealed the results of a double-blind trial this fall, the drug proved no more effective than a placebo.
The depression story is typical of the way Mr. Gilmartin steadfastly has trusted his scientists, even as other drug companies have made strides to cushion their exposure to the erratic performance of their research divisions. At public forums, Mr. Gilmartin has always deferred to his highly credentialed research chiefs. Edward Scolnick, a Harvard M.D. and former National Cancer Institute researcher, led Merck's research from 1985 until last year when he was replaced by Dr. Kim, a former biology professor at the Massachusetts Institute of Technology.
Dr. Scolnick now is paid $600,000 a year to "engage in scientific research" at Merck and is entitled to use the company plane to fly to conferences but isn't involved in management decisions any more, according to a proxy filing.
Most of Merck's deals with smaller companies involve technologies such as genome analysis that could help Merck scientists with their work, rather than ready-made drugs that might push aside Merck's own research. The drugs it does license are usually at an early stage of testing -- which puts the onus on Merck's scientists to test and market the product. For example, the diabetes drug that failed came from a Japanese company, Kyorin Pharmaceutical Co., in 1999 and hadn't been tested for efficacy in humans yet.
One exception is a deal Mr. Gilmartin struck with Schering-Plough in 2000 to share rights to a novel cholesterol-lowering drug called Zetia. Today Zetia is the lone bright spot among Merck's new products. Merck expects to get approval next year from the Food and Drug Administration to sell a pill that combines Zetia with Zocor, its existing cholesterol drug. The combination pill appears to match the cholesterol-lowering power of the strongest currently marketed pill, AstraZeneca PLC's Crestor.
Otherwise the cupboard is virtually bare. Zocor, which recorded more than $5 billion in world-wide sales last year, has already lost patent protection in parts of Europe and will lose U.S. patent protection in 2006. Merck's annual profit could plunge at that point. Its next big medical breakthrough -- a vaccine for the human papilloma virus, which is linked to cervical cancer in women -- probably won't be ready until 2007 or later.
Merck has also had some bad luck with its existing products. It had originally anticipated double-digit growth for many years in its painkiller Vioxx, but some studies have suggested a slight increase in heart-attack risk among those who take it. U.S. sales of Vioxx in the first three quarters of this year were down 28% to $1.1 billion. "That was really a problem -- and it was an unexpected problem," says one person close to Merck's management.
Even as the company's woes deepened this year, Mr. Gilmartin has shown little outward concern. He embarked on a nationwide tour to talk about the proposed prescription-drug benefit in Medicare and other broad health-care issues. Last week, for example, Mr. Gilmartin spoke at a community-development gathering in Pittsburgh. The CEO's speech marathon also took Mr. Gilmartin to Seattle and Tallahassee, Fla., among other places.
Some analysts say Merck could still keep profits rising modestly if its major products, such as the osteoporosis drug Fosamax, continue to rise at a double-digit pace. But Merck's share price reflects the market's expectation that profits will stay flat or fall. Merck shares are changing hands at around $41, and the company expects to earn just under $3 a share this year, so its price-to-earnings ratio is about 14. Other drug makers have much higher ratios -- 29 for Eli Lilly and 22 for Johnson & Johnson, for example. A higher price-to-earnings ratio means investors have bigger expectations for growth.
Mr. Gilmartin has taken steps address the situation. In October, he announced he was laying off 3,200 employees, or about 5% of the full-time work force. He also says that behind the scenes an effort begun around 2000 to do more deals is beginning to bear fruit. He disputes the view that Merck is less interested in licensing drugs that have undergone extensive human testing, saying his team is "really engaged" in looking for drugs at all stages of development.
But Mr. Gilmartin shows no signs of considering bolder change such as a merger with Schering-Plough, nor does the board appear in a rush to make him do so. "Merck is having a little rough patch now but they're going to get through it," said Lawrence Bossidy, a former chief executive of Honeywell International Inc. who is viewed as the board's most powerful outside member, in an interview last month. "We're convinced that we're going to have a bountiful future."
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PIPELINE PREDICAMENT
In March 2002, Merck said it planned to start selling or file for approval of 11 drugs by 2006. What's happened since then:
DRUG TREATMENT STATUS
Zetia Cholesterol Launched November 2002, profits shared with Schering-Plough
Emend Chemotherapy-induced nausea Launched April 2003
Zetia-Zocor combination pill Cholesterol Filed November 2003, profits shared with Schering-Plough
Human papillomavirus vaccine Cervical-cancer prevention Filing planned by 2006
RotaTeq Rotavirus infection prevention Filing planned by 2006
Arcoxia Pain Delayed
Integrase inhibitor AIDS Delayed
GABA-A a2/a3 agonist Anxiety Cancelled
PDE-4 inhibitor Asthma Cancelled
Aprepitant Depression Cancelled
MK-767 Diabetes Cancelled
Source: the company
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