Drug Firms Trying to Ease Doubts of Investors

Has a disease hit the renowned pharmaceutical industry?

Respected companies are drawing doubts and questions. Merck & Co., a leading firm with a reputation for strong scientific research and financial returns, has hit a lean patch with few new drugs and no growth in earnings. Its stock is down 33% in the last two years.

Bristol-Myers Squibb Co. is being judged foolish for investing $2 billion in ImClone Systems Inc., a small company with a promising cancer drug that couldn’t handle the intricate process of applying for drug approvals with the Food and Drug Administration. Bristol-

Myers’ management has stepped

in to rectify matters, but the company’s stock is still down 20% from its high of last year.

What’s going on?

A crucial industry is demonstrating just how difficult technological and financial success can be to maintain. It now requires investment of $800 million on average to develop a major drug. So stock market values are particularly important to drug companies. They require enormous capital to finance the research and clinical trials that go into drug development. A relatively low stock price can force even the strongest firms to take short-term actions that lead to long-term regrets.

In fact, the drug industry today is merging into larger firms, operating from headquarters in the United States and Europe. Size is needed for the ability to keep a continuing stream of new drugs coming to market as other drugs go off patent.

Patent protection on a prescription drug lasts for 17 years but dates from a midpoint in the drug’s research, so the average drug has about 12 years of patent-protected earning in the marketplace, Merck Chairman Raymond Gilmartin said recently in a speech.

Merck today offers a particularly clear example of the crosscurrents of modern medicine and modern capital markets. Gilmartin has told investment analysts that after a decade in which Merck’s earnings growth averaged 16% a year, profit in 2002 would be flat with last year--about $7 billion, or $3.14 a share.

Merck has half a dozen of its most important drugs going off patent, including the high blood pressure medicine Mevacor and the ulcer drug Prilosec. Once patents expire, generic, cheaper versions of the drugs hit the market and Merck makes little profit from them.

A single major drug can support a global business by itself. Merck’s anti-cholesterol drug Zocor, for example, will have about $7 billion in worldwide sales this year. But it goes off patent in 2005.

Merck’s problem is that for the next few years, it has no major drugs coming along to replace the others. A drug it counted on, the arthritis remedy Vioxx, is not delivering the sales anticipated and has run into problems involving side effects.

At times like this, companies often seek a merger, says analyst Bob Kirby of investment firm Edward Jones & Co. But not Merck. Resisting Wall Street suggestions that it merge with

Eli Lilly & Co. or acquire Schering-Plough Corp., Merck’s executives say the company will be better off on its own, pointing to its research and development.

The company is certainly not cutting back. Merck this year will spend $2.9 billion on R&D;, a 16% increase from 2001, and $2.5 billion more on development of laboratories and other facilities for research.

A major part of Merck’s research is pursuing brain and nervous-system medicines, including drugs to alleviate the effects of Alzheimer’s disease, and new forms of tranquilizing and antidepressant drugs. The company promises to introduce 11 major new drugs by 2006.

It planned ahead. In 1999, Merck paid $80 million to acquire Sibia Neurosciences, a San Diego start-up that has become the nucleus of a Merck research center in La Jolla.

Meanwhile, scientific work continues on vaccines against AIDS and medicines to help chemotherapy patients and asthma sufferers.

Will the financial markets support all that research and investment?

“Probably they will, based on Merck’s track record in drug development,” says analyst Mark Ravera of Mehta Partners, a New York research firm that specializes in the global drug industry.

And Merck may make a move or two to bolster its stock price. The company announced recently that it would sell part of its Medco division, which manages prescription costs for hospitals, in a public offering and spin the rest of the division off to shareholders. The Medco spinoff would bring in cash and leave Merck a pharmaceuticals-only firm, which Wall Street analysts favor.

And it could open the way for Merck to acquire Schering-Plough, with which it already is pursuing joint research on anti-cholesterol and arthritis medicines, says analyst Michael Krensavage of investment firm Raymond James & Co.

“That kind of heavy petting often leads to more,” he says.

But why would Merck acquire Schering-Plough, which has

$10 billion in annual sales, when it has said it feels no need to merge? Because a merger could come in handy to bolster the stock price if research on some of its new drugs hits a wall.

Analysts recall that Pfizer Inc. three years ago said it had no intention of merging but then fought off competitors to acquire Warner-Lambert Co. and get full control of its Lipitor drug, the leading cholesterol-reducing medicine.

Bristol-Myers, which is pursuing research on cancer drugs in its own laboratories, may have felt the need to shore up its capabilities in oncology by acquiring an interest in ImClone’s Erbitux drug, which may be able to shrink colorectal tumors.

The need to balance the demands of science and finance is critical.

“This is a high-risk, high-growth industry and so investors demand high returns,” says analyst Kirby of Edward Jones.

Successful companies such as Merck and Pfizer typically return 30% to 40% a year on capital invested, among the highest rates of profit in U.S. industry.

In recent decades, drug firms have earned those high rates of return by developing drugs to alleviate heart disease, multiple sclerosis, Parkinson’s disease and other illnesses.

But financial markets are impatient taskmasters and react with alarm at any sign of faltering in the rates of financial returns or scientific discovery. That’s why Merck is scrambling to quell today’s doubts and fulfill tomorrow’s promises.

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James Flanigan can be reached at jim.flanigan@latimes.com.