Merck's magic act loses dazzle

A general view shows the Merck facility in Rahway, New Jersey November 28, 2005.

NEW YORK (Reuters) - The glory is quickly fading for drugmaker Merck & Co, which dazzled investors over the past three years by recovering from a crisis over its Vioxx painkiller and rolling out blockbuster products.

For now the stock is looking more like a valuation play than a bet on its fundamental business outlook.

Much of the luster came off on Monday, when it was announced that the company's Vytorin cholesterol fighter had failed to successfully treat patients with heart valve damage.

What's more, patients taking Vytorin developed cancer at a greater rate than those taking placebos, even though experts said that was probably due to chance.

To further dismay investors, second-quarter earnings not only showed a marked slowdown in sales growth for its Gardasil vaccine against cervical cancer but also a decline in sales of asthma drug Singulair, usually a dependable earner.

Merck's refusal to reaffirm its previous 2008 earnings forecast, citing new uncertainty about Vytorin's sales outlook, was the final straw for many investors.

"This is hard to believe," Sanford Bernstein analyst Tim Anderson said in a research note, saying Merck's real reason for holding back may have been lower than expected sales of big products such as Singulair and Gardasil.

Shaken investors have bailed. Merck shares fell 6.2 percent on Monday and dropped another 11 percent on Tuesday to a 30-month low as other industry analysts also cut their earnings forecasts, citing similar concerns about growth prospects.

"We can no longer recommend putting new money to work in Merck," said Leerink Swann analyst Seamus Fernandez, who noted that Merck slashed full-year sales forecasts for Gardasil by $500 million and cut its Singulair forecast by $200 million.

Fernandez now expects Merck to post average annual earnings growth of 4 percent between 2007 and 2012, down from his earlier forecast of 6 percent.

BUY SIGNAL?

Vytorin has been on the downswing since January, when it proved no better than a generic cholesterol fighter at cutting plaque in neck arteries.

Sales of pricey Vytorin have been hurt by intense media coverage questioning its value, despite its ability to slash levels of "bad" LDL cholesterol by as much as 60 percent.

Vytorin and another cholesterol drug, Zetia, also sold with Schering-Plough Corp, helped Merck regain its footing after it recalled Vioxx, its $2.5 billion-a-year arthritis drug, in September 2004 due to safety concerns.

All this has put CEO Richard Clark back in the hot seat.

Clark, who had been head of manufacturing, took over in May 2005 and was credited for quickly turning around the company's earnings and share price.

The transformation was fueled by sales of Vytorin and Zetia as well as by the introduction of Gardasil and a fast-selling diabetes drug called Januvia.

Clark has also cut costs across the board, including eliminating 20 percent of the U.S. sales force.

Some say cost-cutting may be reaching its limits.

"At this point, they're cutting into the bone and I have to believe that at some point it will start hurting morale and be counterproductive," said Steve Brozak, an analyst with WBB Securities in Westfield, New Jersey.

Brozak said that Merck, to remain competitive, now needs to increase its focus on potentially lucrative biotech drugs that target disease-causing proteins.

"They should look for as many biotech companies, projects and academic collaborations as humanly possible," Brozak said, noting that Swiss rival Roche Holding AG was taking that approach by offering more than $43 billion for shares of Genentech it does not already own.

Although Merck has forged drug-development deals with a number of biotech companies over the past three years, Brozak said it needed to pick up the pace.

After sharp declines this week, Merck shares have now lost all gains seen during Clark's tenure as CEO. The sheer magnitude, in fact, may now have become a buy signal.

"While we struggle to find a silver lining in the confluence of negative events for Merck shares yesterday, we see limited downside in the shares," J.P. Morgan analyst Chris Schott said in a research note.

Even before Tuesday's big selloff, Schott said Merck shares were trading at a 20 percent discount to already-depressed stock prices of rival drugmakers -- at 10 times Merck's expected 2008 per share earnings.

Thus, he stuck to his "overweight" rating on the drugmaker, which is based in Whitehouse Station, New Jersey.

Eldene Doyle, at Oblique Capital Management, said Merck has long been on her wish list as a possible investment.

"They have a lot of good things going on, including Januvia and a migraine drug in late-stage testing," Doyle said.

"But I'm waiting to see how Vytorin shakes out, because Merck might not be such a good value unless it turns around."

(Reporting by Ransdell Pierson; editing by Ted Kerr)