Does Merck Need A Major Restructuring?

Two months ago, newly installed Merck R&D chief Roger Perlmutter eliminated various senior management roles and hinted further changes are in the offing in hopes of jumpstarting the unit (back story). This was only the latest instance, though, in which the big drugmaker has reorganized to prove its mettle to Wall Street. In 2011, Merck began chopping up to 13,000 jobs in order to save up to $1.5 billion by 2015, and that came on top of previously announced cuts (see this).

But apparently Merck is not moving fast enough for everyone. In a research note, Leerink Swann analyst Seamus Fernandez upped the ante by writing that a “major restructuring at Merck is necessary” and should be "seriously considered." Why? So far this year, Merck revenue growth has been “relatively lackluster,” he writes, and slashing R&D would be a “well-received move” by investors. In fact, he estimates that every $1 billion cut in operating expenses would boost Merck shares by 25 cents.

Actually, Fernandez is being kind by describing top-line growth as lackluster. For the first six months of the year, Merck sales fell nearly 10 percent, to nearly $21.7 billion. Meanwhile, R&D spending was essentially flat at roughly $4 billion, which means R&D spending accounted for 18.5 percent of sales compared with 16.7 percent during the same period last year. And marketing and administrative expenses fell 3 percent, to $6.13 billion, but accounted for 28.3 percent of sales, up from 26.3 percent (see page 2).

He further cites disappointments in the lab, such as a delay in seeking approval for an osteoporosis drug due to a need for additional trial data; FDA rejection of a sleeping pill (see this,; and a decision by the agency to cancel an advisory committee meeting to review a surgery drug in order to assess results of a recently inspected clinical trial site, suggesting the possibility of data problems. And last December, Merck pulled its Tredaptive cholesterol pill after a study showed it failed to prevent heart attacks, strokes and deaths more than traditional statin drugs that lower bad cholesterol (more here).

As he sees it, pressure is building on Merck to do something and a big overhaul would improve R&D productivity, maintain “top tier” operating margins and continue returning cash to shareholders. By chopping $1 billion from expenses, Fernandez writes, the absolute spending on R&D would bring Merck closer to the roughly $6.5 billion that Pfizer , its main rival, currently spends, but remain in line with spending by several “diversified competitors” at 14 percent of sales. A 10 percent cut in overall operating expenses would equate to about $2 billion in annual cost reductions, he writes.

Of course, throwing employees overboard is nothing new in the pharmaceutical industry when investors get impatient and Merck, in fact, has been a key practitioner of job cuts, especially since its $41 billion acquisition of Schering-Plough four years ago. The deal was supposed to help replenish a pipeline populated with drugs facing generic competition, but never delivered on its promise. Toward that end, former Merck R&D chief Peter Kim retired earlier this year, despite having a sizeable budget to generate new medicines.

For the record, a Merck spokesman had no comment on any restructuring moves.