Quick Analysis Of Merck’s Acquisition Of Cubist

Merck (NYSE:MRK) has announced that it will acquire Cubist Pharmaceuticals for $8.4 billion. This year has been busy with M&A (mergers and acquisitions) activity in the pharmaceutical industry  and Merck has been especially focused on mid-sized acquisitions. However, there has been a twist with this proposed transaction in which, shortly following its announcement, a US court invalidated four of five key patents covering the company’s flagship product, Cubicin. If upheld, the ruling will allow generic competition to commence in mid-2016, when the remaining patent expires.  The invalidated patents would have allowed patent protection to extend to 20190 and 2020. Here is our take on the rationale behind the acquisition and the impact of the ruling on Merck’s future revenues.

Our price estimate for Merck stands at $52.50, implying a discount of more than 10% to the market.

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What Opportunity Does The Acquisition Present For Merck?

The acquisition will give Merck a quick access to the antibiotics market and help it offset the revenue decline it has faced in recent years. The company expects the move to add more than $1 billion to its topline in 2015. Like other big pharmaceutical firms, Merck’s revenues have fallen due to the loss of patent exclusivity of key drugs. As a result, it has been focusing on making medium sized acquisitions to gain patent and marketing rights to promising new drugs and the associated R&D pipelines. The current acquisition fits that strategy. Antibiotics makers are benefiting from a revival in the market incentives. The companies that develop antibiotics are now eligible for quicker FDA approvals and longer patent protection periods. Cubist, and its Cubicin, is especially effective in treating against pathogens (common in hospitals) that have developed resistance to conventional antibiotics.   With Cubist, Merck secures a significant position in this key under-served market.  The company’s foray in this arena makes sense considering these circumstances.  Treating diseases caused by such bacteria will require more advanced versions of these drugs and we expect Merck to try and be first to the market when it comes to launching follow-on treatments. As far as Cubist is concerned, the acquisition will give it access to more funds and strong international marketing channel. The company still sells mainly in the U.S. and Canada.

How Does Premature Loss Of Patent Impact The Deal?

Soon after Merck’s acquisition announcement, a federal judge invalidated some of Cubicin’s patents which means that a generic version of the drug can be launched as soon as 2016. This is roughly 2 years earlier than expected. Merck still wishes to go ahead with the acquisition but this definitely means that the deal is more expensive for the company now as compared to before. Cubicin’s sales stood a little short of $1 billion in 2013, accounting for about 80% of Cubist’s revenues. A two year reduction in the patent period will imply that the future revenues (during 5 year period beyond 2016) could be $2.5 billion lower than previously expected. This is based on our estimate for future growth of Cubicin and expected decline in revenues following loss of patent exclusivity. However, Merck believes that the acquisition is in the long term interest of both the companies, which is what we have established above.

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