Serono Acquisition Boosts Q1 Sales at Merck KGaA, but EBIT Drops 53.3% Y/Y on Costly Consolidation

Merck KGaA's first-quarter (Q1) financial performance has been coloured largely by the recent consolidation of Swiss biotech Serono into the company's Ethicals division, forming the new Merck Serono. The 10.2-billion-euro (US$13.9 billion) acquisition helped push sales up by 33.4% year-on-year (y/y) during January-March, reaching 2.1 billion euro, while total group revenues expanded by 37% y/y to stand at 2.2 billion. Research and development (R&D) costs increased dramatically over the period as well, reflecting Serono's multitude of mid-to-late-stage trials; for the company as a whole, R&D spending was up by 52.5% y/y and totalled some 296.4 million euro, the bulk of which came from the Merck Serono unit, where research costs were up by a staggering 89.2% y/y to 232.3 million euro.

The rise in spending associated with the takeover did not prevent an 11.4% y/y rise in operating profit, which stood at approximately 321.1 million euro on 31 March, although earnings before interest and taxation did take a heavy 53.3% y/y hit, contracting to 125.6 million euro. This was largely due to 196 million euro in "exceptional items" brought about by placing price allocations on Serono inventories. These write-downs are to be spread equally across the four quarters of 2007, meaning that EBIT will be suffer negative effects on a similar basis throughout the remainder of the year.

The Merck Serono unit is by far the biggest of Merck KGaA's Pharmaceuticals division, as well as the fastest-growing, although the extreme levels of first-quarter sales growth are obviously due to first-time consolidation effects. Tipping the scales at just over 1 billion euro, Merck Serono accounted for some 64.6% of Merck's total pharmaceutical turnover during the first quarter. By comparison, the division's two other units, Merck Generics and Consumer Health Care, saw only slight growth in sales of 3.9% y/y and 2.0% y/y, respectively. Merck is still in the process of deciding on a suitable candidate to whom it can sell its Generics business, with the most recent press reports hinting that Actavis (Iceland), Mylan Laboratories (U.S.), Teva (Israel) and Torrent Pharmaceuticals (India) are the main contenders (see Germany: 29 March 2007: Merck KGaA Anticipates Binding Bids for Generics Unit Only by End-April).

Rebif Snatches Limelight…

Former Serono product Rebif (interferon beta-1a), a treatment for multiple sclerosis, had sufficient sales to outstrip Merck KGaA's former top-seller, Erbitux (cetuximab), with first-quarter turnover of 283 million euro. Rebif's sales were up 3.5% y/y on a reported basis but saw an increase of 8.6% y/y in organic terms, largely driven by an impressive 23% y/y rise in sales to the United States. The pace of sales growth for Rebif has, however, cooled noticeably in just one quarter, with the last three months of 2006 seeing a 16% y/y rise in turnover for the drug.

…But Pace of Erbitux Growth Remains Unbeaten

Oncology drug Erbitux, Merck KGaA's long-time top seller, may have been pushed into second place by Rebif, but was easily the fastest-selling product of any in the Merck Serono portfolio. Erbitux sales shot up by some 48% y/y over the quarter, reaching 110 million euro in all. This strong financial performance came despite a number of setbacks for Erbitux over the period, including the persistent refusal by the U.K. National Institute for Health and Clinical Excellence (NICE) to make the drug available free of charge on the National Health Service (NHS) for the second-line or subsequent treatment of metastatic colorectal cancer in combination with irinotecan cytotoxic therapy or as combination treatment with radiotherapy for locally advanced squamous-cell cancer of the head and neck (see United Kingdom: 6 February 2007: NICE Preliminary Guidance Rejects Merck KGaA's Erbitux for Head and Neck Cancer and United Kingdom: 26 January 2007: NICE Turns Down Appeal on Merck KGaA's Erbitux for Bowel Cancer).

Elsewhere in the Merck Serono portfolio, the first-quarter performance of drugs was somewhat mixed. While the likes of psoriasis Raptiva (efalizumab) continued to show strong double-digit levels of growth, infertility treatment Gonal-F saw its sales growth come to a complete halt year-on-year, at 112 million euro. The product even saw a 15.2% y/y slide in quarterly sales compared to the final three months of 2006. Sales of diabetes treatment Glucophage (metformin) also came sliding to a halt year-on-year, at 65 million euro.

Outlook and Implications

Merck KGaA is expecting full-year organic sales growth in the high single digits in all units except Merck Generics, which the company is aiming to divest before the end of the year. In terms of operating profit, the outlook is more favourable, with Merck predicting a "comfortable double-digit rate of increase", with amortisation of intangible assets from Serono fully factored in. The guidance for full-year turnover does not reflect the one-off inflating effects of the consolidated Serono sales. It appears that the incorporation of Serono drugs into the Merck Serono portfolio, while unquestionably boosting the overall value of pharmaceutical sales, has done little in the way of adding strong growth-drivers to the mix. Adding new indications to existing drugs is one way to ensure an increase in future growth, but recent clinical trial data from ImClone and Bristol-Myers Squibb (both U.S.), who own the U.S. rights to the drug, indicate that Erbitux has failed to meet primary endpoints in late-stage trials for both head-and-neck and metastatic colorectal forms of cancer (see United States: 17 April 2007: ImClone and BMS Disclose Details of "Failed" Erbitux Study and United States: 11 April 2007: Erbitux Fails to Achieve Primary Endpoint in Pancreatic Cancer Study). Looking at the company's research pipeline, Rebif has already been filed with the European and U.S. authorities for approval in the extended indication of relapsing forms of MS, while liposomal cancer vaccine Stimuvax is in Phase III trials for MUC1-expressing tumours including non-small-cell lung cancer. Safinamide is also in Phase III testing as an add-on treatment to a dopamine agonist in early-stage Parkinson's disease and as an adjunct therapy to levodopa in mid-to-late-stage forms of the disease. By successfully divesting its Generics business, Merck KGaA will have added resources to fund further costly late-stage development of Merck Serono product candidates.