Analysing the business of Merck and Davanrik

Analysing the business of Merck and Davanrik The recommendation is that, Merck should license the new drug Davanrik. The company is facing serious situation that most of their drug patents are going to expire soon. For maintaining companys value and profit, it is vital to invest into new drug development. In the other part of the report, a preamble of Merck and Davanrik, decision support data and the answers of important questions are provided in detail. Merck The Company is discovering new innovative products and developing new indications for existing products the result of its continuing commitment to research (Annual Report, 2000). Several products face expiration of product patents in the near term. U.S. product patents expired in 2000 for Vasotec and Pepcid and will expire in 2001 for Prilosec, which is supplied exclusively to AZLP, Prinivil and Prinzide, for which co-marketing rights have been licensed to a third party, Mevacor and Vaseretic. In the aggregate, domestic sales of these products represented 19% of Merck human health sales for 2000 (Annual Report, 2000). The patent expiration can cause deeper drop in overall sales. (Mercks Consolidate Balance Sheet: See Appendix A) Davanrik Davanrik originally developed by Lab Pharmaceutical Company to treat depression. Lab Pharmaceutical offered Merck to license her new developing drug. Lab Pharmaceutical is only 15 years old company. FDA has recently denied to approval one of their drug which completed all three phases. In response to this decision, Lab lost 30% of her overall sales. As a result, LAB was hesitant to issue additional equity to finance the testing of Davanrik and was seeking a larger pharmaceutical company to license the drug and provided the following facilities: Needed Cash Fund for clinical testing Manufacturing and Marketing Royalty on the eventual sales of Davanrik Decision Support Data Merck The patent of Mercks most popular drug is going to expire by 2002 Expiration of Patent can cause a deeper drop in overall sales. Merck needs new drug development to maintain its values and refresh portfolio. The company sales reflect continuous growth in earnings. The success of Davanrik would keep Merck Company in the black for the following seven years, while the failure of Davanrik would ultimately force Merck Company to quickly develop other profit producing drugs. Davanrik and Merck Davanrik is drug compound for treatment of depression and neurological disorders. Its need 7 years or more to approve form FDA in three phases. Phase I would take 2 years. It was expected to cost $30 million, including an initial $5 million fee to Lab for licensing the drug. There was 60% chance that Davanrik would successfully complete Phase I Phase II would take 2 years. It was expected to cost $40 million, including $2.5 million fee to Lab. Phase III trial would cost $200 million including a $20 million payment to lab. Merck Co. should analyze the following different types of factors to make a decision to license Davanrik: Expected revenue Expect royalty fees to lab License fees for each phase Success probability at each phase Marketing cost Merck responsibility at each phase Phase I Testing would cost $30 million including $5 million to lab Total duration of phase 2 years Probability of Success 60% Phase II Testing would cost $40 million including $2.5 million to lab Total duration 2 years Probability of success for depression only 10%, for weight loss 15% and for both 5% Phase III Cost and success probability are depend on the result of phase II Testing would cost for depression only $200 million including $20 million to Lab and probability is 85% Testing would cost for weight loss only $150 million including $10 million to Lab and probability is 75% Testing would cost for both (Depression and Weight loss) $500 million including $40 million to Lab and probability is 70% Depression only cost $250 million to launch with a PV of $1.2 billion Weight loss only cost $100 million to launch with a PV of $345 million Both depression and weight loss would cost $400 million to launch with a PV of $2.25 billion Overall Failure Risk Questions and Answers Should Merck bid to license Davanrik? How much should they pay?   There is an extreme risk of failure in taking Davanrik. However, pharmaceutical drug producing industry does have to be risk seeking, because no any drug can get an approval. It is recommended that Merck Co. should accept Lab pharmaceutical offer for Davanrik. The expected value of Davanrik is around $14 millions. What is the expected value of the licensing arrangement to LAB? Assume a 5% royalty fee on any cash flows that Merck receives from Davanrik after a successful launch.   LAB would also receive a 5% royalty fee on any from future sales of Davanrik separate from the milestone payments and regardless of the costs associated with getting the drug to market. Expected value of the licensing arrangement to Lab: Phase I (100% chance of success): $5 million Phase II (60%): 2.5 million Phase III depression (10%): $20 million Phase III weight loss (15%): $10 million Phase III both (5%): $40 million Depression Success (85%): $1.2 billion * 0.05 Weight Loss Success (75%): $345 million * 0.05 Depression Success [Lower path] (15%): $1.2 billion * 0.05 Weight Loss Success [Lower path] (5%): $345 million * 0.05 Both Success (70%): $2.25 million * 0.05 How would your analysis change if the costs of launching Davanrik for weight loss were $225 million instead of $100 million as given in the case?   Analysis is depending on the success probabilities and failure risks. At phase III, there is only 5% chance of success on weight loss. BY using decision tools the values will be calculating again. What other issues should Merck consider in taking this decision?   Merck Co. should consider the cost of marketing, administration and overall sensitivity of each testing phase. The royalty, cost and overall failure risk is also vital factors to be considered for the decision. Merck should also consider that their drugs patents are going to expire and their many other drugs are not approved by the FDA. How has Merck been able to achieve substantial returns on capital given the large costs and lengthy time to develop a drug?   Merck Co. is a big and economically stable company which can afford large costs and lengthy time to develop a drug. In other hand Lab pharmaceutical is a small company which is not very flexible to handle such type of task. Research and Development is the strength of Merck. Once the drug approve, Merck can produce it for long time period. Appendix A Source: Mercks Annual Report 2000 Appendix B Source: Unknown