Merck seeks the right alchemy for growth

Being chief executive of the world's oldest pharmaceuticals company gives Karl-Ludwig Kley a certain perspective on the ups and downs of business life.

Merck of Germany has been selling medicines since Friedrich Jacob Merck opened a pharmacy in Darmstadt in 1668. It is still 70 per cent owned by the founding family.

"History is not only legacy; it also provides direction," says Mr Kley. "This long-term view is in the company's genes."

Patience was needed after Mr Kley took the reins in 2007 and shareholder returns stagnated, but the past year has seen the stock surge more than 60 per cent as growth prospects have improved.

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This strategy culminated in a $17bn deal last year to buy Sigma-Aldrich, a US laboratory supplies company, and another worth $2.6bn to buy speciality chemicals manufacturer AZ Electronic Materials.

Once the Sigma acquisition is completed, pharmaceuticals will account for little more than 40 per cent of Merck's business, compared with two-thirds when Mr Kley took over.

This has been welcomed by investors and analysts who note the company's failure to bring a new drug to market for more than a decade.

Yet Mr Kley rejects suggestions that Merck is turning away from the business upon which it was built. In fact, much of the investor optimism stems from a belief that its drug development fortunes could be about to change.

Merck last November struck a deal with Pfizer to jointly develop a type of cancer medicine known as an anti-PD-L1 checkpoint inhibitor.

The partnership, under which Pfizer agreed to pay Merck $850m upfront with a further $2bn subject to success, has made the German company a serious contender in the race to develop a new generation of cancer therapies that harness the immune system to destroy tumours.

Mr Kley admits Merck still has much to prove. The $13bn acquisition of Serono, a Swiss biotech company, in 2006 failed to reinvigorate research and development. "We're good at the R but not the D," he says.

The Pfizer partnership will be the first big test of whether years of restructuring have made Merck's R&D operations more productive. "The jury is out," says Mr Kley. "The proof will be registration [of new drugs] and market presence."

Even if successfully developed, Merck's anti-PD-L1 treatment will face stiff competition from a wave of similar products being developed by rivals including its bigger US namesake, Merck & Co, known as MSD outside North America. The companies share common roots but were separated during the first world war, when Merck's American business was confiscated by the US government.

Today, the pair are distinguished by their differing strategies. Whereas US Merck is solely focused on pharmaceuticals, its German parent has built a buffer against the volatility of drug pipelines and patents.

By supplying laboratory tools through its Merck Millipore division, the German company benefits from industry-wide investment in medical research regardless of the outcome of its own drug development. The acquisition of Sigma-Aldrich should make it a more formidable competitor to rivals Thermo Fisher Scientific and GE Healthcare.

The high-tech materials division, meanwhile, is benefiting from rising demand for LCD televisions and other flat screen devices. Competitiveness against Asian manufacturers is a "constant battle" but one Mr Kley believes is being won through quality and innovation.

All three divisions increased sales last year on an organic basis - pushing total revenues up 4 per cent to €11.3bn, driven by emerging markets. There are pressures from heavy R&D spending on the cancer programme and rising competition for the best-selling Rebif multiple sclerosis drug, but growth should get a boost when the Sigma deal is completed - due around the middle of the year.

Mr Kley says the long-term view of the family owners does not reduce pressure on management. "You shouldn't imagine the family sitting back on a beautiful sofa admiring the company. The family is pushing hard, always challenging."

But he acknowledges he has been given more time to find the right alchemy for growth than might have been the case with more fluid ownership. Mr Kley, 63, confirms that planning for his own succession is under way, amid widespread expectations that his deputy, Stefan Oschmann, will take over next year.

After nearly a decade of transformation, it will be up to the next chief executive to deliver the full benefits.

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