Merck & Company: Evaluating a Drug Licensing Opportunity
Case Summary

Merck & Company (Merck) a large pharmaceutical company was approached by LAB Pharmaceuticals in 2000 for the purchase option to license and provide funding for a newly developed drug compound called Davanrik. If Merck, the licensee purchased the compound it would be responsible for the design, administration, and funding of the clinical testing of the compound, as well as take care of its manufacturing and marketing. LAB the licensor would receive an initial payment followed by additional payments as Davanrik completes each clinical testing phase. Davanrik was initially developed to treat depression but during the pre-clinical development process the drug not only blocked antidepressant receptors but also blocked the receptor that causes hunger allowing the compound to angle it to treat depression and obesity.

At the time Mercks most popular drugs such as Pepid, Prinivil, Vasotec, Mevacor’s patents were due to be expired in 2002. Since generic substitutions would essentially replace these compounds, Merck could stand to lose almost 50% of its sales revenue equating to a $5.7 billion loss if it did not come up with a new drug to bring to the market. Under the current conditions of potential loss Rich Kender, the Vice President of Financial Evaluation & Analysis at Merck was considering acquisition of the new compound Davanrik from LAB. Kender worked with a tem to decide whether the company should license Davanrik. Merck must also decide and conduct an analysis of how much to bid for the license and potential of failure/success of the drug.

An analysis was conducted to evaluate the potential profitability of Davanrik by looking at the market and market size, researching the scientific aspects of the compound, and potential competition. Manufacturing managers determined the capital required to produce the drug and a financial analysis of the licensing decision was completed to see if the compound would be profitable and the likelihood of completing each stage of the 7 year FDA approval process. A statistical decision tree analysis was performed as well as estimates of the expected value from each possible outcome based on Mercks cash flows. The estimated expected value had an NVP of 13.98 or $13.98 million. The table of calculated expected values for all phases was multiplied by each milestone, payment, and by probability. The expected values of royalty payments were calculated using the gross cash flows by multiplying a 5% royalty to probability. The total of the expected values of milestone payments to LAB was $9.8 million and the total expected value of royalty payments grossed up by 5% to LAB was $7.23 million. Based on the analysis Merck should bid on the license of Davanrik for no more than $13.98 million. Davanrik has substantial growth potential and potential profits. Although with a $400 million product launch the best case of the drug compound being approved to treat both depression and obesity would account for a present value of $2.25 billion. Merck should acquire the compound from LAB pharmaceuticals even if the drug is approved for only one indicator. The worst scenario is Davanrik being approved to treat only weight loss it would cost $100 million to launch and have a present value of $345 million which is still an investment on the initial recommended contributed capital bid of $13.69 million. Therefore Merck would benefit by purchasing Davanrik from LAB pharmaceuticals, as there is value added and sizable growth and income earnings from the acquisition of the compounds license.