Fitch Ratings revises Merck & Co.'s outlook

Nov 18 2008

Fitch Ratings has affirmed Merck & Co.'s (Merck) ratings, and revised the Rating Outlook to Negative from Stable.

The ratings affirmed are:

• Long-term Issuer Default Rating (IDR) at 'AA-';
• Senior unsecured debt rating at 'AA-';
• Bank loan rating at 'AA-';
• Short-term IDR at 'F1+'.

The ratings apply to approximately $6.93 billion of outstanding debt. The Rating Outlook is Negative.

Merck is in the middle of a period of intellectual property losses during which four of its top-selling drugs will potentially face generic competition. Two major drug products, Zocor and Fosamax, have already lost market exclusivity over the past two years. The period of patent expiry extends until 2012, when the company faces the potential patent loss of its highest revenue generator, Singulair. Additionally, Merck's research and development (R&D) program, which had been highly successful in prior years, has experienced recent delays in key projects, including Tredaptive in the U.S.

Fitch's Outlook revision reflects an estimate of flat- to slightly declining revenues over the long term, as potential commercialization of the R&D pipeline will not fully offset declines due to the maturing drug product portfolio, with the worst effect on revenues in 2010, and lessened impacts in 2012 and 2013. Given the challenges to the company's intellectual property position, Merck's credit profile is dependent on operating cost efficiencies gained from ongoing restructuring activities as well as improving equity income from its joint ventures, most notably the Merck/Schering Plough joint venture.

Fitch recognizes that Merck has undertaken significant restructuring activities over the past few years, including major programs announced in 2005 and 2008, to control operating costs during the current wave of drug patent expirations. Cost cutting efforts have led to a moderation of manufacturing costs as well as a reduction of marketing expenses, yielding EBITDA margins for 2007 and the latest 12-month period ending Sept. 30, 2008, above that experienced prior to the patent loss of the company's then top-selling product, Zocor, in June 2006. However, Fitch expects continued pressure through the intermediate term on equity income received from the company's cholesterol joint venture with Schering-Plough Corp. due to significant sales declines of Vytorin and Zetia.

Liquidity is not a major concern, as Merck had full capacity of its $1.5 billion revolving credit agreement (due in April 2013) at the end of the third quarter, as well as strong free cash flow generation. The company had cash and short-term investments totaling $6.84 billion at the end of the third quarter, despite restricting $5.1 billion for the U.S. Vioxx product liability settlement during the quarter. Merck benefited from the partial redemption in March of its joint venture with AstraZeneca, which resulted in a cash inflow of approximately $2.6 billion after netting out the $1.38 billion loan due to AstraZeneca. There is no significant debt maturity until 2015 (approximately $1 billion); however, anticipated near-term borrowings from a letter of credit vehicle used to fully fund the Vioxx litigation settlement are expected to be paid through the intermediate term.

Merck still has significant litigation exposure from a wide range of previous and new legal cases, including those pertaining to Vioxx and now Zetia/Vytorin. The U.S. Vioxx product liability settlement and the closure of numerous investigations of past sales and marketing practices this year has removed considerable uncertainty; however, patent challenges to key pharmaceuticals remain and Fosamax product liability has arisen.

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