2013

Merck and Company: Evaluating a Drug Licensing Opportunity

Subject: Quantitative Techniques III Professor: Prof. Bhavin J. Shah Group No: 3 Date: 6th March, 2013 IIM Indore PGP Mumbai Batch of 2014

Prepared By: Ankur Sinha (03) Arvind Kumar (05) Gunreet Kaur Thind (11) Karri Kartik (14) Pradyoth C John (23) Sandeep Sayal (28) Abhijeet Panwar (35)

Table of Contents
1. INTRODUCTION........................................................................................................ 3 1.1 Situation Analysis3 1.2 Objective..3 1.3 Problem Statement..3

2. ANALYSIS ................................................................................................................... 4 2.1 Alternate course of action ............................................................................................. 4 2.2 Decision Tree.................................................................................................................. 5 2.3 Should Merck bid for the license? ................................................................................. 6 2.4 Expected value of licensing arrangement to LAB .......................................................... 6 2.5 Sensitivity analysis.8 3. REFERENCES.........................9

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1. INTRODUCTION
1.1SITUATION ANALYSIS RELEVANT CASE FACTS
Merck is a global research driven pharmaceutical company that discovers, develops, manufactures and markets a broad range of human and animal health products. Merck earns most revenue from a handful of patented drugs. The company continuously refreshes its product portfolio by developing new drugs directly or through joint ventures. This is very important for the company to sustain high growth year after year. LAB Pharmaceuticals has developed a drug, Davanrik, to treat both depression and obesity. LAB had previously tried to get approval for one of its compounds but was unsuccessful. So it had decided to partner with an established Pharmaceutical company to conduct clinical trials. The licensing agreement would require Merck to conduct the clinical trials, market the drug. Lab would earn via licensing fees - royalty on sales and milestone based payments. After the approval, the patent protection will last for about 10 years.

1.2 OBJECTIVE
Rich Kender, Vice President of Financial Evaluation & Analysis at Merck, was working with his team to decide whether Merck should license Davanrik.

1.3 PROBLEM STATEMENT

Should Merck license the Davanrik? If yes, what should be the licensing fee? How sensitive is this decision on future cash flows associated with various costs?

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2. ANALYSIS
2.1

Alternate course of Action

License the drug Do not license the drug

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2.2 Decision Tree

Launch 0.85 Phase 3 success 1 -200 0.1 Depression(Phase II) 0 -40 537.5 0.15 Phase 3 fail -270 -200 -270 1 Revenue 25 -100 1 -150 0.15 Weight loss -40 -36.25 0.25 Phase III fail -220 -150 -220 1 Revenue 1280 -400 1280 2250 1280 25 Don't launch -220 0 -220 25 345 25 -270 680 -270 -250 680 1 Revenue 680 1200 680

Launch 0.75 Phase III success

Launch 0.7 Dual(Phase III success) 1 -500 1280

0.6 Phase I Success -30 43.3

Dont launch -570 0 -570 1 Revenue 380 380 1200 380

Launch 0.15 Depression(Phase III success) -250 1 -500 380 Dont launch 0 -40 879.75 Launch License 0 13.98 0.05 Weight loss(Phase III success) -100 1 -500 -325 Dont launch 0 0.1 Phase III fail -325

0.05 Dual

-570 -570 1 Revenue -325 345 -325

-570 -570

-570 -500 1 13.98 Fail -70 -40 0.4 Phase I fail -30 -30 -30 -70 0.7 -570

Dont License 0 0 0

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Since the EMV of the decision tree is positive, Merck should license Davanrik. From consolidated income statement, we could calculate the retained earnings as a percentage of income before taxes. Retained earnings as a percentage of PBT = This should be maintained for this deal as well. Hence the most Merck could pay as licensing fee is = 37.84% of $ 13.98 million = $ 5.29 Million

2.3 Should Merck bid to license Davanrik?

As the expected monetary value for licensing the drug is positive ($ 13.98 million), Merck should license Davanrik.
Probability Failure Phase I Phase II Phase III 0.4 0.42 0.009 0.0225 0.003 0.85 Expected value $ Million Phase I Phase II Phase III 12 46.8 71.8 3.375 1.5 135.475

Depression Weight Loss Dual

Money at stake

Total

From the table above, we could see that expected value for failure is $ 135 million. Also, since the payments are to be made on basis of milestones, Merck would have the advantage of pulling out on later stages if progress is not made. The chances of failure reduce dramatically once the drug passes Phase II testing. So Merck will risk losing $ 70 million only. Once the drug passes Phase II, the chances of success are very high and it would only require additional investment of $ 65 million.

2.4 What is the expected value of licensing arrangement to LAB? (5% royalty assumed)
The cash flows of LAB are : 1. $ 5 million initial licensing fee in Phase I ( irrespective of success of Phase 1)
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2. $ 2.5 million in Phase II (Probability of occurrence 0.6) 3. Phase III a. $ 20 million if the drug cures only depression (Probability of occurrence 0.1) b. $ 10 million for weight loss only (Probability of occurrence 0.15) c. $ 40 million if drug cures both depression and weight loss (Probability of occurrence 0.05)

What LAB expects Initialization Phase I Phase II

Total

Cash flows ( $ millions) 5 1.5 Depression 1.2 Weight Loss 0.9 Dual 1.2 9.8

Formula .6*.25 .6*.1.*20 .6*.15*.10 .6*.05*.40

Expected royalty to LAB Gross cash flows ($ millions) Royalty 1200 345 1200 245 2200

% Probability 5% 5% 5% 5% 5% 5.1 6.75 0.45 0.15 2.1

Depression independent Weight Loss Depression dual Weight Loss dual Dual only Total

Expected 3.1 1.2 0.3 0.1 2.4 6.9

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2.5 How would your analysis change if the cost of launching Davanrik for weight loss were $ 225 million instead of $ 100 million?
Decision tree for the new scenario is:
Launch 0.85 Phase 3 success 1 -200 0.1 Depression(Phase II) 0 -40 537.5 0.15 Phase 3 fail -270 -200 -270 1 Revenue -100 -225 1 -150 0.15 Weight loss -40 -130 0.25 Phase III fail -220 -150 -220 1 Revenue 1280 -400 1280 2250 1280 -100 Don't launch -220 0 -220 -100 345 -100 -270 680 -270 -250 680 1 Revenue 680 1200 680

Launch 0.75 Phase III success

Launch 0.7 Dual(Phase III success) 1 -500 1280

0.6 Phase I Success -30 28.925

Dont launch -570 0 -570 1 Revenue 380 380 1200 380

Launch 0.15 Depression(Phase III success) -250 1 -500 380 Dont launch 0 -40 873.5 Launch License 0 5.355 0.05 Weight loss(Phase III success) -225 1 -500 -450 Dont launch 0 0.1 Phase III fail -450

0.05 Dual

-570 -570 1 Revenue -450 345 -450

-570 -570

-570 -500 1 5.355 Fail -70 -40 0.4 Phase I fail -30 -30 -30 -70 0.7 -570

Dont License 0 0 0

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From the tree, we could see that launching weight loss when the launching fee is $ 225 million would lead to losses. However, net EMV of the decision tree is still positive. Hence Merck should still license the drug. Case (i) If Merck finds out the Davanrik can cure only weight loss after Phase II, it should not proceed any further. Since the loss incurred ($ 70 million) will be less than the loss ($ 100 million) if the product is launched. Case (ii) If Phase II indicates dual efficacy and Phase III results in efficacy for only weight loss, then Merck should go still launch the product as it will result in lower losses ($ 450 million) than abandoning the product ($ 540 million)

3. LIST OF REFERENCES
Richard S.Ruback, Merck & Company: Evaluating a Drug Licensing Opportunity. Harvard Business School Case 9-201-023 25 March, 2003.

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