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Merck Shares Drop After Spinoff Announced

·3 min read

Merck & Co. Inc. (NYSE:MRK) was a drag on the Dow Jones Industrial Average on Feb. 5. While the DJIA soared more than 483 points, Merck shares slumped $2.53 to $85.83. It appears the decline was tied to the company's long anticipated announcement that it was spinning off its women's health and biosimilars businesses as well as lower-than-expected fourth-quarter sales, including a mild revenue disappointment for its key drug.

Overall fourth-quarter revenue rose 8% to just under $12 billion, just missing expectations. During the final three months of 2019, sales of Merck's blockbuster cancer drug Keytruda climbed more than 45% to just over $3 billion, but analysts had set the bar higher. Merck did just beat on adjusted earnings, which jumped 12% to $1.16.

Keytruda sales for all of 2019 rose 55%, reaching $11 billion. The increase was tied in great part to the expansion of the drug's label to treat more than 12 types of cancer.

Besides Keytruda, Merck has the post-surgery drug Bridion, whose sales rose 24% to $313 million during the quarter, and a host of vaccines. The company promoted the spinoff as a way to eliminate a distraction from its core business. It says it will now make it easier to pinpoint where it should spend on research and development and business development opportunities, according to an article in BiopharmaDive.

According to CEO Ken Frazier, the yet-to-be-name spinoff, simply referred to as NewCo, will enable Merck to better prioritize and support a group of products that no longer fit in the company's strategic framework. He emphasized that the products remain important to public health and the patients who use them, adding that "if managed and resourced appropriately, present real opportunities for growth."

While the restructuring has been long rumored, some investors seemed blindsided. "I can't come up with a good explanation as to why this transaction came out of left field," Evercore ISI analyst Umer Raffat wrote in a note to investors.

Others were concerned about the risks the move could pose, according to an article in FiercePharma. "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," RBC Capital Markets analyst Randall Stanicky said in a note to investors. He added that any initial hit to earnings would likely be a short-term phenomenon.

Frazier said the time was right for the spinoff because Merck no longer needs the cash the legacy products were throwing off to support the company's oncology business, referring specifically to the growing success of Keytruda.

The business to be separated is expected to account for revenue of $6.5 billion in 2020. The transaction should be completed during the first half of 2021.

The new company will be headed by veteran Merck executive Kevin Ali; Carrie Cox will serve as board chairman. She has extensive experience in the pharmaceutical industry and deep expertise in women's health. The new company will have upwards of 10,000 employees and be headquartered in New Jersey. It will assume $8.5 billion to $9.5 billion of Merck's debt. NewCo is expected to start out with low single-digit revenue growth, but Merck thinks it has the opportunity to improve on that figure if the product portfolio realizes its potential.

Disclosure: The author has no position in Merck.

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This article first appeared on GuruFocus.