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Merck joins peers in spinning off lower growth drugs

Merck & Co. is riding high on the success of its cancer drug Keytruda, post-surgery drug Bridion and portfolio of vaccines. But certain parts of the business may be distracting from that growth story.

That’s why on Wednesday, along with a full-year earnings report, Merck announced it is spinning out biosimilar, women’s health and legacy drugs into a new, yet-to-be-named company. Merck estimates the spinout drugs, which include the off-patent cholesterol pill Zetia and the Remicade copycat Renflexis, will fetch about $6.5 billion in revenue this year.

“By spinning off NewCo as a distinct business, we can better prioritize and support a set of products that no longer fit in Merck’s strategic framework, but which remain important to public health and the patients who rely on them — and which, if managed and resourced appropriately, present real opportunities for growth,” Merck CEO Ken Frazier said on a call with investors.

Merck claims the spinoff simplifies the core business, makes it easier to invest in research and development, and improves the existing company’s ability to prioritize pipeline and business development opportunities. By turning these drugs into an independent, publicly traded company, Merck expects to receive $8 billion to $9 billion through a tax-free dividend. Merck also expects to realize more than $1.5 billion in operating efficiencies by 2024, at which point the big pharma hopes to have at least a 40% operating margin.

As for the new company, it will be led by Kevin Ali, a Merck veteran who was most recently in charge of the drugmaker’s enterprise portfolio strategy initiative. Carrie Cox, former chairman of the Pfizer-acquired Array BioPharma, has been named chairman of the new company’s board of directors.

The new company will be headquartered in New Jersey, with an employee count of about 10,000 to 11,000. It will also take on $8.5 billion to $9.5 billion of Merck’s debt. Merck expects that in 2021, when the spinoff is expected to complete, the new company will start with low single-digit revenue growth but have “substantial growth potential” in the women’s health and biosimilars markets.

Merck has hinted in previous years that a restructuring was on the table. Yet Wednesday’s announcement did seem to catch Wall Street off-guard.

“I can’t come up with a good explanation as to why this transaction came out of left field,” Evercore ISI analyst Umer Raffat wrote in a Feb. 5 note to investors.

On the call earnings call, the first question Merck executives received was about their rationale for doing the spinoff now.

“This is about taking actions today that will ensure the long-term growth and viability of Merck,” Frazier said.

“So from our standpoint, this is the right time. A few years ago when we were looking at this, we saw the opportunity but, for example, the cash flow generation of our legacy products was being employed at that time in standing up our oncology business, which we grew from the ground up and, as you know, has been extremely successful.”

Sales of Keytruda, the cornerstone of Merck’s oncology efforts, rose 55% in 2019 to reach $11 billion. Merck’s extensive research has led to approvals across more than a dozen cancer types — so many, in fact, that indications take up almost the entire first page of the drug’s label.

Merck is also finding growth in Bridion and human vaccines, sales from which rose 23% and 15%, respectively, last year. In Merck’s vaccine portfolio, Gardasil/Gardasil 9 sales increased 19% to $3.7 billion while the Proquad, MMR II and Varivax franchise increased 27% to $2.23 billion.

While Wednesday’s announcement may have been a surprise to some investors, the move isn’t unprecedented. Pfizer recently offloaded its Upjohn unit, which housed off-patent brands such as Lipitor, Lyrica and Viagra, through a merger with Mylan. A year earlier, before it was bought by AbbVie, Allergan had plans to sell off its women’s health and infectious disease units.

GlaxoSmithKline, meanwhile, created some buzz Wednesday as it detailed a two-year program meant to split the core company from its consumer healthcare segment, which was merged with Pfizer’s consumer business in a joint venture set up in December 2018. Earlier that year, GSK had paid Novartis $13 billion for the Swiss pharma giant’s stake in a joint consumer healthcare venture between the two companies.

Merck shares were down 4% at market’s open Wednesday.