MERCK & COMPANY: EVALUATING A DRUG LICENSING OPPORTUNITY

Merck & Company: Evaluating a Drug Licensing Opportunity

Merck & Company: Evaluating a Drug Licensing Opportunity

Executive Summary

In 2000, Merck & Co., Inc., a global research-driven pharmaceutical company, was facing a threat that patents of their most popular drugs would expire in two years. Following by the patents' expiration, company's sales and profits would decline dramatically since generic substitutes would take place. The only way to recover the loss caused by patents' expiration was to develop new drugs and refresh the company's portfolio.

LAB Pharmaceuticals, who specializes in developing compounds for treatment of neurological disorders, offered Merck to license a new developing drug, Davanrik, which had functions to treat depression, obesity or both. At the time of the offer, Davanrik was in pre-clinical development, which would need to pass the three-phase clinical tests approved by the FDA. Testing would last seven years, which would appear to be high failure and costly. Under the licensing agreement, Merck would be responsible for the approval of Davanrik from the FDA, its manufacturing, and its marketing. As return, Merck would pay LAB an initial fee, a loyalty on all sales, and make additional payments as Davanrik completed each stage of the approval process.

As Merck's financial evaluation team, we analyzed this offer through decision tree analysis, and estimated the expected value from each possible outcome and the expected payments to the LAB. We concluded the expected value of licensing Davanrik is around $13.69 million, which included the expected payments to the LAB of $16.68 million.

The following analysis of Merck and Company was to thoroughly examine a drug licensing opportunity with LAB Pharmaceuticals, a small pharmaceutical firm. This firm has offered to allow Merck and Company rights to further development of the drug called Davanrik. The analysis includes calculations of probability and decision trees using the Microsoft program Excel. It is assumed that given probabilities are correct, however sensitivity analyses were conducted to show the overall effect of cost and probability changes. Risk was also considered as a major factor in this analysis. It has been determined that Merck & Company should accept the offer from LAB Pharmaceuticals because of the predicted revenue. The relative risk involved with this project is high; however, it has been determined to be part of the nature of the pharmaceutical industry and previous drug development endeavors.

Our recommendation is that Merck should bid on licensing Davanrik no more than $13.69 million. First, the company is facing a serious situation that most of their patents are going to expire soon, and the company's value and profits are declining, so it is necessary to invest in new drug developments. Second, the FDA approval tests are seven years long with a high failure rate.

Background

The nature of the pharmaceutical industry includes a variety of factors. Three of these factors will be described. First, development of a drug can take several decades and therefore pharmaceutical companies incur large research and development expenses with no revenue in ...