Merck's Partnership With NGM Is A Bold Move

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Last week Merck ( MRK ) signed a deal with NGM Biopharmaceuticals, which we believe is a bold and a long-term move. Under the multi-year agreement, Merck will make a payment of $95 million to NGM to establish a co-development alliance and  acquire another 15% equity stake for another $106 million. The company also offered $250 million of additional funding for any new drugs that the biopharma firm develops going forward. The deal gives a lot of flexibility and room for taking risk to NGM. It is a bold move considering there is only one disclosed compound in pre-clinical stage by NGM and it seems that Merck is essentially paying a premium to acquire its team of researchers and scientists. Nevertheless, NGM's focus on biologics is a big part of rationale behind this move. Considering the decline in R&D productivity for chemical drugs, Merck and other big pharmaceutical firms are looking for new avenues for growth. As a result, we are witnessing a lot of activity in mergers and acquisitions area, along with research collaborations. Most of this activity is focused on immuno-oncology drugs and other biologics.

Our price estimate for Merck stands at $52.50 , implying a discount of about 10% to the market.

See our complete analysis for Merck

Between 1967 and 2007, the average ROIC (return on invested capital) for pharmaceutical and biotech firms was 23.5%. We forecast Merck will generate an ROIC of roughly 35% annually for the foreseeable future and perhaps target even a higher rate with this investment. We attribute this above average return to Merck's track record as well as its emphasis on strong drug research. With many small molecule drugs losing their patent protection and very few such promising candidates in the pipeline, pharmaceutical firms are looking to shift their focus to biologics and immuno-oncology drugs. In fact, Pfizer's recent acquisition of Hospira indicates the company's interest in biosimilars, which are generic versions of biologics and have just started to gain traction. Eitherway, biologics are likely to be the future of drug research and Merck's bet on NGM is a bold move in this direction. The company is looking at ways to revive its growth and stem revenue losses. In 2014, Merck's revenues declined by 4.1% and the outlook for year 2015 isn't too good either. In fact, Merck is planning to reduce its R&D spending in the coming year which suggests that the bet on NGM is born out of strong confidence in the company's team.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Investing Ideas , Stocks , US Markets
Referenced Symbols: MRK , RHHBY , PFE

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