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The Other Merck Soars on Liquid Crystal Business

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Germany’s second leading pharmaceutical firm and one of the biggest family controlled organizations in this sector Merck KGaA recently released its quarterly results that topped estimates on the back of a cost cutting drive. The pharmaceutical company doesn’t have much attractive in its current pipeline, yet it continues to attract investment because of its unique sales mix — drugs and liquid-crystals, a market whose oversupply problems are finally coming to an end.


The German Merck is an old rival of the US based pharmaceutical giant Merck & Co (NYSE:MRK). The two companies separated after the First World War under the Treaty of Versailles in 1919 and the two now have the right to use the name Merck under different geographic locations. Merck & Co’s market cap is about $100 billion bigger than that of its German competitor.

Merck KGaA’s most recent quarterly results, which came out in the first week of March,  showed a 16% increase in non-GAAP EBIT of $1.027 billion as opposed to analysts’ estimates of $1 billion while profits increased by 104.5% to $353.58 million. The business is aiming to save $390 million by 2014 and $500 million by 2018, each year, through various austerity initiatives including the closure of facilities and reduction in headcount.

Its healthcare arm is mainly known for its cancer drug Erbitux and multiple sclerosis medicine Rebif, whose sales volume is threatened by severe competition. The firm’s long term plan is to reduce its exposure to its home market and push for expansion into the U.S, Japan and China, key markets of Merck & Co.

Merck KGaA is expecting a significant increase in income in the current and next year. Erbitux came to the market in 2003 and the firm has not produced a follow up product since then.  Its acquisition of water purification firm Millipore two years ago and workforce reduction efforts have sustained its growth levels. In the beginning of 2011, Merck KGaA did an overhaul of its top executives and brought new ones from Novartis (NYSE:NVS), GlaxoSmithKline (NYSE:GSK) and Merck & Co.

Although the weak development pipeline won’t create any problems in the short term (two to three years) in the long term it could significantly impact sales which will begin shrinking in 2015.   Merck KGaA won’t have a new drug coming out until at least 2016.  However, unlike Merck & Co, it is not just a drug manufacturer and niche water purifier but the biggest player in the global liquid-crystal market – and this is the reason why investors are not shaken up due to its weak pipeline.

Merck KGaA is the largest manufacturer of liquid-crystals for flat panel televisions. It has used the weak Euro, like a lot of German manufacturers, to fuel exports, but in Merck’s case it’s to China.  Materials costs are incurred in Euros and sold to the Chinese who have a fairly strong peg still to the U.S. Dollar.

China has become a strong TV consumption market, overtaking Japan.  Moreover, the problems associated with oversupply in the TV-panel industry seems to be over and specialty glass industry leader Corning (NYSE:GLW) is expecting a rise in TV sales in the current year with growth in larger screen TVs.   In the current quarter, the performance materials unit (liquid crystals), posted an impressive 21% increase in sales to $541.17 million.

Renewed euro weakness due to the issues in Italy, Spain and now Cyprus should continue to support the liquid crystal currency arbitrage.  Because of this and a more diversified revenues stream than its American namesake, the German market has shown confidence in Merck and the company’s stock closed at an all-time high on Thursday. The company has been one of the biggest gainers in the FTSE 350.

On the other hand, Merck & Co, a Dow Jones (NYSE:DIA) component, was one of the few stocks that missed the current record rally. Merck & Co. offers a juicy yield of 4% — with a payout ratio of 85%.  Pharmaceuticals, in general are reporting falling sales  due to loss of valuable patents to generics, specifically Singulair for Merck.

Like Merck and Co. Merck KGaA, doesn’t have a potential blockbuster drug like Singulair in its pipeline though some new products look promising, and that’s a real problem since it derives 89% of its revenue from drug sales.   And with the real growth markets in drugs place like Southeast Asia where intellectual property gets little to no respect, patent monopoly is not a viable growth model and a strategic challenge going forward.

Merck KGaA*

Merck & Co.



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* Merck KGaA (ETR:MRK)

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