Merck Serono: The Power of Two

September 1, 2007

Pharmaceutical Executive

Volume 0, Issue 0

It's testimony to the high anxiety-and hectic activity-in the industry that the merger of German chemicals-to-pharmaceuticals firm Merck KGaA and Swiss biotech Serono elicited only faint fanfare. Both family-owned drugmakers boast an illustrious heritage, but their union garnered none of the pomp and circumstance befitting a marriage of European royalty.

It's testimony to the high anxiety—and hectic activity—in the industry that the merger of German chemicals-to-pharmaceuticals firm Merck KGaA and Swiss biotech Serono elicited only faint fanfare. Both family-owned drugmakers boast an illustrious heritage, but their union garnered none of the pomp and circumstance befitting a marriage of European royalty.

"German Merck" traces its roots back to a mid–17th century apothecary in Darmstadt owned by Friederich Jacob Merck. His descendant, Emmanuel, discovered alkaloids in 1816 and began manufacturing them in bulk, thereby launching what is now the $600 billion drug industry. Serono, founded in 1906 in Italy, created the fertility market, helped produce the first test-tube baby, and was the world's third-largest biotech at the time of its centennial.

Yet late September 2006 was a bizarre time for privately owned midsize European pharma mergers. In addition to the Merck-and-Serono match, UCB Pharma bought Schwartz Pharma AG, and Nycomed snatched Altana's pharmaceutical division. "Europe's family-owned drug companies are fast becoming an endangered species, struggling to survive in an increasingly challenging regulatory and competitive environment," wrote the Wall Street Journal—as if penning an obituary.

IMS Health's Murray Aitken was more sanguine, aptly naming the sudden trend self-defense. In his firm's annual report, he wrote, "Call it the price of independence or the cost of sustainability. By merging, these companies have become more difficult for the giants to swallow whole."

Elmar Schnee, the new CEO of Merck Serono SA, agrees. "In terms of research and innovation, Merck KGaA's R&D investment on its own fell too short to really be competitive in today's environment," he says plainly. Discussing the merger in the press, he was at pains to emphasize that it delivered a $1.3 billion investment in R&D—that all-important "critical mass." He also trumpeted its best-of-both-worlds biotech–pharma versatility: A Merck–Serono team could go bio a bio with giants like Amgen and Roche as well as compete in the small-molecule arena with the likes of Sanofi-Aventis and Schering-Plough. The new entity had combined 2006 pharma sales of $5.3 billion, a total of 28 pipeline compounds, and a global sales fleet of 7,000. By most metrics, it has vaulted into the Big Pharma Top 20.

But even German analysts were playing it cool. "This isn't an act of desperation," said Karl Heinz Scheunemann, of Bankhaus Metzler. "It's a fit, but no bargain," said Union Investment's Markus Manns. In fact, at the news that Merck KGaA had ponied up $13.3 billion, its shares fell as much as 6.5 percent.

A case of damning with faint praise? Not really. Analysts increasingly describe Big Pharma M&As in terms of "desperation" and driven by "product panic." And while no one would call Merck KGaA's branded pharmaceuticals dynamic, the company's deep pockets—its generics division earned $2.5 billion last year; its chemicals division, $2.8 billion—and reputation for discipline have earned it respect.

"It's a Rip Van Winkle story," says Jeff Moe, who heads the Duke University Fuqua School of Business's Health Sector Management. "Here you had a sleeping pharma division at an otherwise successful company that finally woke up, took stock of the new reality, and made some decisive moves."

Still, Merck KGaA's behavior leading up to the merger had seemed uncharacteristically erratic. Its future had darkened a bit when saritozan went bust in Phase III; the company was developing the novel treatment for Parkinson's disease as a follow-up blockbuster to Erbitux, the EGFR-inhibitor Merck KGaA markets outside North America. That's when the firm decided to hit the acquisition trail with a vengeance.

In an all-German tug-of-war, Merck KGaA first tried for a hostile takeover of Schering AG, but it was outbid by Bayer. Still, it persisted with "a last-minute attempt to snatch back Schering from under Bayer's nose," according to Global Insights. "[This] left players on the German pharma market wary of its tactics, and most probably persuaded it to look elsewhere in Europe for a suitable target." It was at that point that Merck KGaA looked over the Alps to Serono, with its one foot in Geneva and the other near Boston.

The Swiss biotech was nursing a rejection of its own: CEO Ernesto Bertarelli, whose family was a majority shareholder, had decided to put Serono on the block—but no large-cap pharma was buying. Its dashing yachtsman-cum-executive had boosted the bottom line with the development of Rebif for relapsing multiple sclerosis. But once again, the lack of a follow-up blockbuster—coupled with $704 million in fines and a guilty plea to fraud for illegally inducing doctors to prescribe Serostim, its growth hormone for AIDS wasting—had sent Serono's fortunes south.

Rumors were also rife that Bertarelli's sailing ambitions—he and his Team Alinghi won the America's Cup in 2003—had taken a toll on mission and morale. A Pharm Exec source who asked not to be identified recalled seeing Serono headquarters decked with pennants, streamers, and other paraphernalia celebrating an upcoming America's Cup. "I'd never seen anything so crass—or confusing—at a drug company before," he says. "When I found out it was about getting employees excited about the America's Cup—well, no wonder Serono was up for sale."

Elmar Schnee is the pennants-and-streamers type. A Swiss native, the 48-year-old marketing master has spent his career posted at one European pharma or another, rising rapidly. He was named president of Merck KGaA's French subsidiary in 2003; within two years, he was leading the firm's pharmaceuticals sector.

Schnee crisply ticks off for me the five criteria Merck KGaA was looking for in a partner. First, there was R&D critical mass. "Second, we wanted a commercial base in the United States—that was very important," he says. "We had sales there in our generics but not in our branded business." The US market, of course, accounts for more than half of all global sales and is growing at 8 percent; by contrast, the European Union's is half the size, half the growth. In that sense, Merck KGaA had the worst of both worlds; the German market's famously harsh price controls only added insult to injury. Boston-based Serono boasted $800 million in US sales and an 850-person sales force nationwide.

"Third, we have one area focused to specialists—Erbitux, a great success," Schnee says. "But we cannot compete in the primary-care market, so we needed to strengthen our specialty products and pipeline, especially in oncology." Merck KGaA's immediate about-face—turning its attention from Schering AG to Serono—revealed its shrewd appreciation of the moment.

The fourth goal was extending its global footprint, with a special focus on Japan, which has the world's second-biggest market—and a soaring rate of poorly treated cancer. Serono, with its 40 subsidiaries worldwide, fit the bill.

Schnee's final criteria was "diversity in therapeutic areas." Merck KGaA's branded portfolio is, to put it politely, mature: Only Erbitux is on its way up, while only its Concor cardio franchise has depth. Glucophage, the top-selling type 2 diabetes drug, has lost ground to generic rivals.

Likewise, Serono has one big-shot sales driver: Rebif, which delivered slightly more than half of the company's $2.5 billion in global sales last year. But Serono also boasts an impressive recombinant-technology platform; it has developed a franchise in metabolic endocrinology, including Serostim and Raptiva, a monoclonal antibody for psoriasis. However, fertility treatments are what first put Serono on the map, and the biotech is justly admired for its global leadership.

Erbitux, Rebif, and four veteran brands in as many therapeutic areas may offer diversity, but they lack synergy, as analysts noted when the deal was inked. That may be why Schnee is careful to frame it as "not a scale or size merger, but a knowledge and capability merger. Our two companies are complementary, and together create one that in the midsize arena has world-class knowledge in biotech and small molecules." For example, EMD Serono's high-tech know-how can ramp up drug discovery while its manufacturing muscle can pump out batches of Erbitux.

Amerger's chance for success is often said to lie in the quality of the ensuing integration, which can be as artless as a wrecking ball or as precise as a tango. "It can often seem," says Michael Rosen, president of Rosen Bioscience Management, "like a battle of two people trying to impose their will on their partner until they finally meld together to form this couple performing in unison."

In their own tango, Merck KGaA leads and Serono follows—and that's how Schnee prefers it. "You have to give a clear vision very fast to the new company because you have people coming from two different cultures," he says.

The official Merck–Serono consolidation took place in January, complete with fresh faces at the top, including Schnee as CEO and a new CFO. A Merck KGaA board member was put in charge of the integration process, with its 25 teams of some 170 "integration managers." The company began by surveying 7,500 employees. From this, Schnee learned, not surprisingly, that "despite their differences, the Merck KGaA and Serono cultures share certain values: teamwork, excellence, creativity, innovation, customer orientation."

That bodes well for a harmonious tango, especially because Schnee prioritizes "the soft factor." "An integration is decided by the humans, how they cooperate and communicate, how teamwork is built up," he says. "I do not think success depends on, say, how fast you get your rep network together on the road."

Still, Schnee moved fast to start paying down the debt incurred in the merger. In May, the firm sold its generic pharmaceutical division, which accounted for 29 percent of its 2006 sales, to Mylan Labs for a steep $6.7 billion. Merck Serono immediately rebounded to its pre-merger price, but analysts were already demanding results from the pipeline. "The easy money has been made,'' said Andrew Fellows, of London's Helvea. "My concern is their ability to grow that whole pharma business. There is still high dependence on the old Serono products."

Bruckner Group partner Michael Russo casts a cold, if wry, eye on many pharma mergers, which often begin with industry-conquering bravado only to fall victim to their own fantasies of size. "Acquiring Serono buys them time to get that billion-dollar pipeline they like to boast about moving."

Whether Merck Serono will have the time it needs to turn on productivity and stave off predators remains to be seen. Over the next 12 months, all eyes will be on the biopharma's much-touted oncology franchise. A full-court press to expand the indications of Erbitux is a top priority. Phase III trials have had mixed results—positive in metastatic colorectal and head and neck cancers; negative in pancreatic cancer; and equivocal (but ongoing) in non-small-cell lung cancer. As Erbitux developer and marketer outside North America, Merck Serono is testing its EGFR inhibitor against an array of new targets, including breast cancer and gastric cancer.

But the biopharma is not staking the farm on its single breakthrough cancer drug. Erbitux faces increasingly tight competition from Genentech's Avastin and Amgen's Vectibix. Plus, with a price tag of $10,000 a month, says Michael Russo, "Erbitux is the poster child for new super-priced cancer drugs that add a few weeks to your life." Russo also notes that with the large-cap pharmas all rushing to invest in oncology, better drugs are just around the corner, and the high price/low benefit ratio is bound to improve. These advances could lock Erbitux out of the market.

As a result, Merck Serono is exploring other targeted approaches to oncology. Among monoclonal antibodies, it is testing adecatumumab (MT201) in Phase I trials against EpCAM-expressing tumors. On the anti-angiogenesis front, cilengitide is showing encouraging results in Phase II against both prostate and brain cancers. The firm is also testing two immunocytokines, one in Phase II for adult melanoma and pediatric neuroblastoma, the other in ovarian cancer. And it can lay claim to the first-ever therapeutic cancer vaccine, Stimuvax, currently in Phase III for metastatic non-small cell lung cancer.

EMD Serono, for its part, is continuing its aggressive strategy with Rebif, which was boldly pitted in 2002 against a similar interferon, Biogen's Avonex, thereby gaining a competitive edge—and blockbuster status—in the relapsing-remitting MS indication. Now Rebif is in a head-to-head trial with Teva's Copaxone. But with a crop of new oral MS drugs on the way, all these injectables risk being left in the dust. The plan is to squeeze the brand for every drop of potential—as a reformulation, for different subtypes of the disease, and, more ambitiously, possibly even as a preventive. (And as a treatment for hepatitis C—a Phase III study found that patients of Asian origin benefit from it.) Meantime, EMD Serono is stepping up to compete in the oral-MS category with cladribine, which won fast-track status in Phase III for relapsing disease. It is also has two selective inhibitors for MS in its early-stage pipeline.

Several co-development deals are bearing fruit. This fall, Merck Serono plans to submit data to the European Medicines Agency (EMEA) for the orphan drug Phenoptin for pediatric phenylketonuria (Biomartin has the rights in the United States). With ZymoGenetics, the company is testing Atacicept—a recombinant protein that Merck Serono can also manufacture—against a range of targets, including autoimmune disorders, such as lupus and rheumatoid arthritis, and cancers, such as chronic lymphocytic leukemia and multiple myeloma. And to build its neurology category beyond MS, Merck Serono joined with Newron Pharmaceuticals to develop safinamide for Parkinson's, Alzheimer's, and other cognitive disorders; last month, they reported solid results from a Phase III trial.

Mergers are notorious for causing leadership attrition, and one leader Schnee is likely to work hard to hold onto is Fereydoun Firouz, president of Serono's US headquarters since 2003. A Swiss native like Schnee, Firouz, 43, has spent his entire career at the biotech, growing its global business by starting subsidiaries in emerging markets, then taking over the reproductive health division in the United States before moving to the top spot.

Firouz has scored some important successes as an innovator of specialty marketing. "Being in specialized pharmaceuticals, we focus on delivering products to specific populations with serious unmet medical needs," he says. "So, for us, it's not about advertising. Our priority is driving the pipeline and bringing new products to patients—not 'consumers'—while our marketed brands are supported by superior educational, support, and access resources."

Commercializing specialty products for serious diseases like MS requires a certain sensitivity—and the education and support programs developed by Serono are among the best in the business. Branded "Lifelines," the call-centers and home visits evolved, says Firouz, from the company's "exploring a more holistic approach. We are drug discoverers and developers, yes, but ultimately we are talking about an individual coping with a very complex, confusing, even horrendous, chronic disease. A member of my family has MS, so I know how difficult it is."

The medical focus expanded to include community building, with webcasts, telecasts, and local events. The company further deepened its commitment to the MS community last June with MS Lifelines Access Made Simple, offering immediate treatment with Rebif for no more than a $50 co-pay (a year's worth of Rebif runs $22,000), as patients struggle to negotiate the red tape of reimbursement assistance.

EMD Serono has gone on to apply the Lifelines model to its fertility and growth-hormone product lines much as a drug is extended for additional applications. "You could very easily say EMD Serono equals biopharmaceutical company, and biopharmaceutical company equals a vial with a biologic in it. But it's not that at all. In fact, EMD Serono is this entire holistic approach."

EMD Serono's innovative specialty marketing may be a partial bulwark against the encroaching threat of biosimilars. Already authorized in Europe, follow-on biologics increasingly appear to be a fait accompli in the United States, although serious concerns over their efficacy and safety may stall legislation for a year or two. For biopharmas like Merck Serono, there are also serious concerns about innovator exclusivity.

Firouz is an engaged but fair-minded partisan on the issue. "My position is not that we should not have follow-on biologics. But in order for them to be a realistic and viable option for patients, two things need to happen," he says. "First, any company producing biosimilars needs to run the proper clinical trials. Second, the innovators, like Merck Serono, need proper incentives in order to keep up our intensive, high-risk investment in the next wave of innovation. Because, ultimately, what we are here for is to come up with cures."

It is not every day that a pharma leader talks passionately about patient support and cures for disease. As for the bottom line, Merck Serono's second-quarter filings record pharma sales rising 11 percent against last year's, with Rebif up 8.2 percent to a record $420 million for the quarter and Erbitux jumping 44 percent to $156 million. It saw its first drug go to market since the merger—Pergoveris, the first-ever recombinant combo to stimulate fertility. If its late-stage pipeline pans out, Merck Serono could be launching new drugs for major diseases like MS and Parkinson's as well as several treatments for small, but serious, unmet medical needs.

Conventional wisdom has it that the failure rate of mergers—in terms of achieving greater-than-average productivity, not to mention intended goals—is slightly less than that of marriages, about 50 to 80 percent. But based on the bottom line, at year one, it looks like Merck Serono may beat the odds.