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© Queen’s University 2015
QUIC RESEARCH REPORT
QUIC Research Reports focus on
emerging investment themes that
affect current portfolio companies
and companies under coverage.
Consumers & Healthcare
Introduction
With the market for immuno-oncology and biopharmaceuticals
expected to generate significant growth over the next few years, we
believe that now is a good time to add another biotech name to our
portfolio.
Condensed Summary
- Merck is a market leader in the rapidly growing immuno-oncology
and Hepatitis C fields
- Merck is attractively valued relative to comps, and exhibits strong
growth potential
- Merck has one of the largest and most developed drug pipelines,
specifically for immuno-oncology drugs
- Merck is also making innovative developments with its new
Hepatitis C drugs
- We believe that adding Merck to our portfolio will help strengthen
our portfolio by exposing us to the lucrative biotechnology space
Merck & Co. Stock Pitch
A healthy addition to US Portfolio
August 17th, 2015
Daniel Morris
Julie Vincent
Jon Allion
Simon Rezene
QUIC Research Report
August 17th, 2015
Merck:
August 17th, 2015
Table of Contents
Introduction 1
Industry Overview 3
Industry Competitors 4
Company Overview 5
Investment Thesis I – Positioning for Immuno-oncology Exposure 6
Investment Thesis II – Rapidly Advancing Pipeline 7
Investment Thesis III – Attractive Entry Point 8
Catalysts and Risks 9
Valuation 10
References 13
QUIC Research Report
August 17th, 2015
Merck:
August 17th, 2015 3
Industry Overview
2014 was a pivotal year for the healthcare industry,
with a significant increase in M&A activity as well as
an increased focus on research and development of
complex drugs. This momentum has continued into
2015 with numerous multi-billion dollar takeovers
and individual drug companies investing heavily in
their pipelines.
Right now, the industry is changing because of the
implementation of the Affordable Care Act (Obama
Care). Although this will not directly impact
pharmaceutical company in terms of their ability to
innovate, it will increase prescription sales and visits
to medical practitioners. AS more individuals are
covered, healthcare spending will increase
benefitting pharma companies and biotech
companies alike. However, there is some fear that if
the government becomes a large purchaser of
healthcare products, this could result in increased
price controls.
The first major trend in the industry is Immuno-
Oncology and immuno-therapies. Immuno-
oncology is a new and revolutionary form of cancer
treatment. It targets the immune system as a whole,
instead of targeting specific tumour cells like
traditional cancer therapies do. Immuno-therapy
drugs allow the immune system to recognize and
attack cancerous cells which, over time, activates
the immune system’s long-term memory.
This enables the body to continuously fight
cancerous cells, should cancerous cells relapse.
The second trend is bio-printing. Bio-printing allows
for the creation of three-dimensional tissues and
organs which can be used to replace damaged
tissues or cells. Bio-printing works by combining
cultured human cells and a liquid gel known as
“bio-ink” to create layers of human cells
interspersed in hydrogel. Once the tissue has been
printed, it is left to grow naturally and the hydrogel
is removed. Scientists have found that this can help
to reverse degenerative diseases and leads to a
faster recovery for patients with internal ailments.
Many pharmaceutical firms are also looking at bio-
printing as a way of speeding up clinical trials and
lowering their costs of development and testing.
Bio-printing would allow companies to test the
effects and toxicity of drugs, reducing liability of
pharmaceutical firms as well as allowing the firm to
determine whether the drugs are worth being put
through costly clinical trials.
Going forward, we expect pharmaceuticals and
biotech companies to continue converging, leading
to more breakups and spinoffs. Eventually, we see
this leading to drug companies focusing on smaller
niches and pharmaceutical companies focusing on
sustainable growth opportunities and innovation.
Currently Available
•Robotic interventions in surgeries
•Smart watches
•Real-Time Diagnostics
• Inter-disciplinary therapies
In Progress / Available Soon
•Optogenetics
•Robotic Assistants
•Customized mobile health apps
•Artificial organs
•Embedded sensors
•3D printed Biomaterials and
Drugs
Still Needs Time
•Nanorobots in blood
•Augmenting Human Capabilities
•Home Diagnostics
•Gamification Based Wellness
•Full Physiological simulation
•Remote Touch
•Multi-Functional radiology
EXHIBIT 1
Innovation in the Healthcare Industry
QUIC Research Report
August 17th, 2015
Merck:
August 17th, 2015
1 Year Expected Revenue Growth Market Share by Revenue
4
Industry Competitors
Company AstraZeneca BMS Eli Lilly Novartis Pfizer Merck
EV ($MM)
$90,904 $107,248 $92,803 $258,175 $223,376 $182,107
Market Cap ($MM)
$84,413 $105,186 $88,997 $241,759 $217,831 $166,688
2014A Revenue
($MM)
$25,237 $16,383 $19,620 $51,724 $48,196 $40,249
EBITDA Margin19% 20% 23% 33% 39% 58%
Operating Segments Cardiovascular and
Metabolic
diseases;
Oncology;
Respiratory,
Inflammation and
Autoimmunity,
Infection,
Neuroscience and
Gastrointestinal
Cardiovascular,
Virology,
Oncology,
Neuroscience,
Immunoscience
, Metabolics
Human
pharmaceuti
cal products
and animal
health
products
Pharmaceutical
s, Alcon
(eyecare),
Sandoz
(generic
diagnostics)
Global
Innovative
Pharmaceutical,
Global
Vaccines,
Oncology and
Consumer
Healthcare and
Global
Established
Pharmaceutical
Pharmaceu
tical,
Animal
Health
Main Drugs Crestor,
Seloken/Toprol-XL,
Faslodex
Baraclude, HCF
Franchise,
Reyataz
Humalog,
Alimta, Cialis
Diovan, Glivec,
Lucentis
Prevnar, Lipitor,
LyricaJanuvia,
Zetia,
Keytruda
0%
2%
4%
6%
8%
10%
12%
AZN BMS LLY NOVN PFE MRK
$51,724
$48,196$40,249
$25,237
$19,620
$16,383
NOVN PFE MRK AZN LLY BMS
QUIC Research Report
August 17th, 2015
Merck:
August 17th, 2015
Merck serves as a global healthcare provider,
delivering innovative health solutions through its
prescription medicines, biological therapies,
vaccines and consumer & animal health products.
The is split into major divisions consisting of heart
and respiratory health, women’s health and
infectious diseases. Merck was founded in 1891 and
is currently headquartered in Kenilworth, New
Jersey. The company is led by CEO Kenneth Frazier
and in 2015 generated more than $42 billion in
revenues.
Merck is propelled by a strong research and
department division which has led to the approval
of 63 drugs by the FDA as of August 2014 - more
than any other healthcare company. The
company’s products fall into the categories of
vaccines, prescriptions, oncology, consumer
products, animal health products and product
patents. Major products include Januvia, used to
treat type 2 diabetes, Zetia, taken to inhibit the
absorption of dietary cholesterol, Remicade, used
for the treatment of several autoimmune disorders,
Gardasil, a cervical cancer vaccine, Isentress, the first
anti-HIV compound of its kind, and Keytruda, an
immune modulator for the treatment of many
cancers.
Nearly half of Merck’s total revenues are generated
from the United States, with areas from the EMEA
and Asia Pacific also contributing for strong
portions of sales. As of 2014, the company had
operations in 120 countries and factories in more
than 30 factories across the world. The company’s
most recent acquisitions took place in 2014 when
Merck bought Idenix Pharmaceuticals for $3.85
billion and Cubist Pharmaceuticals for $8.4 billion.
The company is committed to creating value and
returning cash to shareholders as evident by the
company’s share repurchase and dividend plan
which has roughly doubled since 2010.
The company’s pipeline involves products in the
biologic, small molecule and vaccine categories.
Merck currently possesses thirty-eight programs in
either the phase II, phase III or under review stages.
Moving forward, the company sees growth
potential in the areas of diabetes, vaccines, hospital
acute care and oncology, and as a result has
focused the future of its R&D strategy in these
divisions.
5
Company Overview
Major Products by Patent Expiration Date
EXHIBIT 4
EXHIBIT 5Merck Geographic Segmentation 2014A
Source: Company Reports
Source: Thomson Reuters
40%
31%
9%
8%
7%3% United
States
EMEA
Asia Pacific
Japan
Latin
America
Other
Product Year of Expiration
Zetia 2017
Januvia 2022
Isentress 2023
Gardasil 2028
Keytruda 2028
Remicade Patent Rejected
QUIC Research Report
August 17th, 2015
Merck:
August 17th, 2015 6
Investment Thesis I: Positioning for Immuno-oncology Exposure
Merck is recognized for their market leadership in
the fastest growing sector in US healthcare:
Immuno-Oncology. After years of research and
development, they have created the most
innovative pipeline, with the highest expected
success rate amongst their peers.
By 2020, the global oncology market is excepted to
reach approximately $112 billion. More specifically,
North America accounts for ~40% of total oncology
sales, and is estimated to be growing at an 8.7%
CAGR. The leading biotechnology firms are based in
the United States, which is currently struggling with
its population structure. The United States is
experiencing an increase in the number of
individuals aged 65+, resulting in an increased
strain on the healthcare system. 63% of all deaths in
the United states result from chronic diseases, with
cancer being the most prevalent). Therefore, the
market for immuno-oncology drugs will continue to
increase.
Recently, Merck acquired a small biotech company
specializing in immuno-therapies called cCam
Biotherapeutics. They are currently in late stage
development of a drug targeted at late stage
cancers, which is so far showing promise. Should his
drug be approved by the FDA, this could result in
large revenue gains for Merck.
Moreover, Merck’s blockbuster immuno-oncology
drug Keytruda has performed extremely well for the
company. Keytruda is known to treat lung cancer of
differing severities far more effectively than
chemotherapy can. Although the drug is extremely
expensive, the company is working on ways to
lower the price in order to allow distribution of the
drug to the maximum number of individuals
possible. Once this is possible, immuno-therapies
will be the new standard in cancer treatment.
EXHIBIT 2
Melanoma
Lung
RCC
Colorectal
Solid Tumors
Hematologic
Merck & Co. Immuno-Oncology Pipeline
Pre – Clinical Phase I Phase II Phase 3 Approval
QUIC Research Report
August 17th, 2015
Merck:
August 17th, 2015 7
Merck’s best in class research and development
program has allowed for an advanced pipeline with
many drugs being processed in all regulatory
stages. The company currently has 13 programs in
phase II (2 advanced), 19 programs in phase III (1
advanced) and 6 programs under review (2
advanced). Merck’s pipeline consists of candidates
in a wide range of disease areas spanning from
atherosclerosis, cancer, cardiovascular diseases,
diabetes, infectious disease, autoimmune diseases,
neurodegenerative diseases, osteoporosis,
respiratory diseases and women’s health.
During 2014, Merck continued to execute on its
strong R&D program through the acceptance of six
products in the USA, granted by the Food and Drug
Administration (FDA). Product approvals included
Keytruda, Belsomra and Gardasil 9. The company
also built its pipeline though acquisitions of Idenix
Pharmaceuticals, OncoEthix and Cubist
Pharmaceuticals. In January of 2015, the company
partnered with Bayer to develop and market novel
therapies for cardiovascular diseases and other
therapeutic indications.
Merck’s largest focus for research and development
currently is tied to the company’s Keytruda
program, designed to cure several cancers. In June
of 2014, Merck announced that the FDA had
granted accelerated approval of Keytruda at a dose
of 2 mg/kg every three weeks for patients with
metastatic melanoma. The Keytruda clinical
development program also includes studies across
a broad range of cancer types including breast,
bladder, lung, stomach, Hodgkin Lymphoma and
head and neck. As of 2012 data, these cancers are
known to be some of the most common across the
globe.
Moving forward, Merck is committed to making
externally sourced programs a greater component
of its pipeline strategy. The company is focused on
a renewed focus on supplementing its internal
research through licensing and an external alliance
strategy focused on the entire spectrum of
collaborations from early research, late-stage
compounds and new technologies.
Investment Thesis II: Rapidly Advancing Pipeline
EXHIBIT 8
Merck Product Pipeline Breakdown
Source: Company Reports
EXHIBIT 9
Top 5 Most New Cancer Cases Diagnosed 2012A (1000s)
Source: World Cancer Research
0
10
20
Phase II Phase III Under Review
Programs in Development Advanced Programs
0 500 1,000 1,500 2,000
Stomach
Prostate
Colorectal
Breast
Lung
Products in Merck Pipeline
Products not in Merck Pipeline
QUIC Research Report
August 17th, 2015
Merck:
August 17th, 2015 8
Investment Thesis III: Attractive Entry Point
EXHIBIT 10
Relative Performance
Source: Capital IQ
EXHIBIT 11
Historical LTM EV/EBITDA
Source: Capital IQ
86
96
106
116
126
136
146
156
166
176
02-Jan-14 02-Jun-14 02-Nov-14 02-Apr-15
MRK S&P/TSX Capped Healthcare Index S&P 500 PFE BMS
10.0x
10.5x
11.0x
11.5x
12.0x
12.5x
17/08/2014 17/11/2014 17/02/2015 17/05/2015 17/08/2015
The Consumers and Healthcare team believes
Merck is currently undervalued relative to its peers
because it’s been able to successfully engage in
expanding its immune-oncology segment. The
growing trend towards oncology treatment has
resulted in high valuations among other players.
Merck’s immune-oncology program is currently
exploring 30+ different tumor types and 40+
different combos but with primarily with proven
but non-proprietary assets or are untested with
Keytruda. With that being said, the continued
success of Merck’s oncology drug, Keytruda, proves
now to be a great buying opportunity. The drug
has recently been approved in the European Union
and is currently under FDA priority review. The
team believes the market will continue to discount
solid Keytruda data, and Merck’s growing oncology
segment.
In addition, Merck has an attractive pipeline (e.g.
Odanacatib, Anacetrapib, BACE inhibitor) that
supports long-term growth.
QUIC Research Report
August 17th, 2015
Merck:
August 17th, 2015 9
Catalysts & Risks
Catalysts
1. 1. Hepatitis C Launch: Prior to releasing Q2
2015 earnings, Merck announced that the Food
and Drug Administration accepted the
company’s New Drug Application and granted
priority review for grazoprevir/elbasvir with a
target action date of January 28, 2016. The
once-daily single-tablet pill is used for the
treatment of adult patients chronically diseased
with genotypes 1, 4, or 6 HCV. The data for
evaluation is from C-EDGE, C-SURFER and C-
SALVAGE clinical trials. The launch is expected
to run through FY 2016.
2. cCAM Acquisition – On July 28, 2015 Merck
announced a signed definitive agreement
under which the company will acquire cCAM
Biotherapeutics, a privately held
biopharmaceutical company focused on the
discovery and development of novel cancer
immunotherapies. Based on the terms of the
agreement, Merck will acquire all outstanding
shares of cCAM for $95 million in cash. The
move is seen as a play by the company to
further enhance their immuno-oncology
pipeline and provides Merck with several early
immunotherapy candidates in early phases of
research and development.
Risks
1. Failure or any further delays of three key
pipeline products in the near future (Suvorexant,
Odanacatib and Cordaptive) could adversely affect
pipeline development and top line growth
2. Competitive threats stemming from increased
investment in immuno-oncology and HCV therapies
by industry peers could affect Merck current
dominant market share and growth prospects.
3. Failure to effectively manage the core
Januvia/vaccines portfolio, as patients who have
used in the drug in the past have filed lawsuits
against Merck.
4. As U.S. government becomes a regulatory body,
the implementation price control within the ACA
may induce a downward pressure on drug prices,
making pharmaceuticals more accessible. Any price
setting by the government would impact revenues
for large pharmaceutical firms.
QUIC Research Report
August 17th, 2015
Merck:
August 17th, 2015 10
Comparables
Analyst Target Prices
Valuation
As evident by the comparables chart above, Merck is trading at a discount compared to its peers on a
price/earnings basis. Although EPS growth is milder for Merck than other companies in the universe, the
company has a dividend yield that is well above the industry average. Finally, on an EV/EBITDA basis Merck
is trading below its peers, displaying the opportunity for strength growth potential moving forward.
$63.00
$64.00
$65.00
$67.00
$66.66
$68.00
$72.93
$55.00 $60.00 $65.00 $70.00 $75.00
Evercore
Barclays
PiperJaffray
Leerink
Consensus
UBS
QUIC
Company Name Market Enterprise P/CFPS Dividend
Cap ($MM) Value ($MM) 2015E 2016E 2015E 2016E 2015E 2016E 2015E 2015E 2016E Yield
Johnson & Johnson $276,551 $261,904 11.1x 10.2x 16.2x 15.6x 6.2% 6.4% nmf 3.6x 3.7x 3.0%
Pfizer Inc. $218,941 $224,172 10.7x 9.9x 17.1x 15.3x 2.1% 2.3% $0.08 4.7x 4.7x 3.2%
Gilead Sciences Inc. $170,859 $174,522 10.4x 9.7x 10.0x 10.1x 11.7% 11.5% $0.26 6.0x 2.3x -
Amgen Inc. $128,743 $98,750 8.9x 8.1x 17.4x 15.9x 9.7% 10.7% nmf 4.8x 4.6x 1.9%
UnitedHealth Group Incorporated $118,070 $126,372 9.7x 8.3x 19.6x 16.9x 6.3% 7.3% $0.14 0.9x 0.7x 1.7%
AbbVie Inc. $114,827 $106,548 10.4x 8.9x 16.3x 13.8x 4.3% 5.0% $0.14 3.8x 4.3x 3.0%
Medtronic plc $111,353 $128,120 12.8x 11.9x 18.0x 16.3x 4.4% 4.8% $0.48 6.4x 4.5x 2.0%
Bristol-Myers Squibb Company $105,836 $107,730 28.1x 22.6x 34.8x 28.2x 1.8% 2.3% $0.86 6.6x 6.9x 2.3%
Mean $155,647 $153,515 12.8x 11.2x 18.7x 16.5x 5.8% 6.3% $0.33 4.6x 4.2x 2.4%
Median $123,407 $127,246 10.6x 9.8x 17.3x 15.7x 5.3% 5.7% $0.20 4.7x 4.5x 2.3%
Merck & Co. Inc. $168,181 $183,410 10.2x 10.1x 17.1x 15.6x 3.5% 3.8% $0.17 4.6x 4.577 3.0%
EV / EBITDA Price / Earnings EPS Growth EV / Sales
QUIC Research Report
August 17th, 2015
Merck:
August 17th, 2015 11
Comparables
We value Merck using a discounted cash flow
model. The cost of equity is derived using the
Untied States 10-year treasury yield of 2.36% and a
market risk premium taken from Professor
Damodaran’s 2015 U.S estimate. Cost of debt is
calculated using a weighted average yield of
Merck’s outstanding debt. WACC was calculated to
be 3.55% based on these estimates. Combined with
an assumed terminal growth rate of 1.5% resulted
in a target share price of $72.93, an implied 26.7%
total return after dividends.
Valuation
WACC Calculation
Risk-Free Rate 2.36%
Market Risk Premium 5.78%
Levered Beta 0.39x
Cost of Equity 4.64%
Cost of Debt 2.79%
Tax Rate 35.00%
After Tax Cost of Debt 1.81%
Capital Structure
Debt 39%
Equity 61%
Total: 100%
WACC 3.55%
Share Price Calculation
PV of UFCF 27,160
Terminal Year Growth Rate 1.50%
Discount Rate 3.55%
PV of Terminal Value 204,358
Enterprise Value 231,518
Enterprise Value 231,518
Less: Total Debt 30,248
Plus: Cash and Cash Equivalents 7,980
Implied Equity Value 209,250
Shares Outstanding 2,869
Implied Share Price $72.93
Current Price $59.00
Target Price $72.93
Dividend Yield 3.1%
Total Return 26.7%
Discount Rate (%)
$72.93 2.55% 3.05% 3.55% 4.05% 4.55%
0.50% 78.69$ 60.88$ 48.99$ 40.50$ 34.16$
1.00% 103.95$ 75.66$ 58.54$ 47.10$ 38.94$
1.50% 153.29$ 99.96$ 72.75$ 56.29$ 45.30$
2.00% 292.32$ 147.41$ 96.13$ 69.97$ 54.14$
2.50% 3,212.04$ 281.14$ 141.78$ 92.47$ 67.30$
Term
inal
Gro
wth
(%
)
QUIC Research Report
August 17th, 2015
Merck:
August 17th, 2015 12
Appendix: Discounted Cash Flow
Historical Period Projection Period
2011 2012 2013 2014 2015 H1 2015 H2 2016E 2017E 2018E 2019E
Revenue
Pharmaceutical 41,289 40,601 37,437 36,042 17,636
Other 6,428 6,412 6,325 5,585 1,803
Corporate 330 254 271 610 468
Total Revenues 48,047 47,267 44,033 42,237 19,907 19,754 41,207 41,247 42,917 44,673
Year over Year Growth % (1.6%) (6.8%) (4.1%) (5.7%) (6.5%) 3.9% 0.1% 4.1% 4.1%
Cost of Goods Sold 16,871 16,446 16,954 16,286 7,108 7,590 14,653 14,254 14,402 14,545
% of Revenue 35.1% 34.8% 38.5% 38.6% 35.7% 38.4% 35.6% 34.6% 33.6% 32.6%
Gross Profit 31,176 30,821 27,079 25,951 12,799 12,164 26,555 26,993 28,515 30,128
Margin % 64.9% 65.2% 61.5% 61.4% 64.3% 61.6% 64.4% 65.4% 66.4% 67.4%
Operating Expenses 23,506 21,608 21,123 19,799 7,108 11,742 20,264 21,089 22,210 23,657
% of Revenue 48.9% 45.7% 48.0% 46.9% 35.7% 59.4% 49.2% 51.1% 51.8% 53.0%
EBITDA 7,670 9,213 8,740 6,132 5,691 422 6,290 5,903 6,305 6,471
Year over Year Growth % 20.1% (5.1%) (29.8%) 85.6% (86.2%) 2.9% (6.2%) 6.8% 2.6%
Less: Depreciation and Amortization 7,427 6,978 6,608 6,691 2,977 3,078 6,291 6,297 6,552 6,820
% of Revenue 15.5% 14.8% 15.0% 15.8% 15.0% 15.6% 15.3% 15.3% 15.3% 15.3%
EBIT 243 2,235 2,132 (559) 2,714 (2,656) (1) (394) (248) (349)
Year over Year Growth % 0.0% 819.8% (4.6%) (126.2%) (1070.7%) 850.0% (102.0%) 33253.0% (37.1%) 41.0%
Less: Income Taxes 942 2,440 1,028 5,349 4,907 (4,887) (0) (138) (87) (122)
Effective Tax Rate 387.7% 109.2% 48.2% (956.5%) 180.8% 35.0% 35.0% 35.0% 35.0% 35.0%
Net Operating Profit After Taxes 699- 205- 1,104 (5,908) (2,193) 2231 -1 -256 -161 -227
Year over Year Growth % (70.7%) (638.6%) (635.1%) 71.1% (100.6%) (102.0%) 33253.0% (37.1%) 41.0%
Plus: Depreciation and Amortization 7,427 6,978 6,608 6,691 2,977 3,078 6,291 6,297 6,552 6,820
Less Capital Expenditures (1,723) (1,954) (1,548) (1,317) (693) (698) (1,443) (1,420) (1,437) (1,515)
% of Revenue 3.6% 4.1% 3.5% 3.1% 3.5% 3.5% 3.5% 3.4% 3.3% 3.4%
Less: Change in Net Working Capital (332) (729) (169) 3,460 (2,552) 3,110 558 558 558 558
Unlevered Free Cash Flow 4,673 4,090 5,995 2,926 (2,461) 7,720 5,405 5,179 5,512 5,636
Discount Period 0.5 1.5 2.5 3.5 4.5
Discount Factor 98.1% 94.5% 90.9% 87.5% 84.3%
Present Value of Unlevered Cash Flows 7,575 5,105 4,709 4,824 4,749
QUIC Research Report
August 17th, 2015
Merck:
August 17th, 2015
References
13
1. Company Reports
2. Bloomberg
3. Thomson Reuters
4. Capital IQ
5. Globe and Mail