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Merck: Not the way to go forward - Outside View

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Merck: Not the way to go forward
May 3, 2010

It is not difficult to see why Merck Ltd - a 52% subsidiary of Merck KGaA of Germany - is not on top of the mind recall, in the pantheon of pharma stocks. For that matter it does not even feature in the investment options of the high strung investment broking fraternity. And it is because of its apparent lack of trying to get around the Indian muddy waters. For whatever reason this 43 year old legal Indian entity represents a muddling has been. A turnover of Rs 5 bn and an after tax profit of Rs 650 m is its magic mantra for the 12 month period ended Dec 2009. It may be pertinent to note that some 45% of its pretax profit of Rs 970 m comprises "other income" - largely made of of interest income on fixed deposits and dividend income from investments in securities.

Not having many clear ideas on how to go forward perhaps, the company has chosen to plonk down some Rs 3.5 bn at year end either with banks or in securities. It does keep shuffling between the two portfolios, not quite sure which investment brings in better returns.

It is however currently implementing one bright idea though - a buyback of shares -a neat trick to increase the hold of the parent over its Indian operations using its accumulated cash surplus - a trend that may well accelerate in the years to come - unless it wises up to other more intellectual diversions. By this method you also gets to report a higher EPS. The other bright idea of flogging its cash surplus was to buy and sell securities during the year - but the effort appears to have been largely wasted.

The problem that MNC pharma companies face worldwide is that they cannot make and market generics as a matter of policy as they do not want to get into bush wars with other MNCs whose products they end up duplicating. They have to stick to pure brands from their own portfolio of products. And its portfolio of products is attracting the Govt big stick.

The management claims that its operations are affected due to the discriminatory application of price controls by the Govt on what it makes and sells especially the bulk drug Vitamin E .The directors' report makes for very sorrowful reading indeed - a diatribe against the many sinful policies of a malignant Govt for the last many years, which is stunting its growth. The net result is that there is no investment in plant and machinery.

For the present its small manufacturing plant based at Goa - and which is highly depreciated to boot-- is being flogged to max capacity - and it also takes recourse to earning some extra moolah through trading operations - and this apparently includes third party processing - trading operations ring in 25% of total revenue. But in the end this effort really does not add up to much in its overall top line. It is not easy to configure how much bottomline is brought in through trading operations but it is reasonable to infer that its contribution is significant.

It also has a pharma R&D unit in Mumbai but its contribution to the company's overall wellbeing is unclear.

The small wonder then is that it still has over 24,000 shareholders at 2009 year end - apparently joining hands with the management in a show of solidarity of sorts.

The only silver lining is that on paper it is an ideal bonus candidate - an equity base of just Rs 166 m topped up with reserves of Rs 4.5 bn. But with the current implementation of its buyback policy and its perceived state of mourning, that is indeed an impossibility.

Disclosure: Please note that I am a shareholder of this company

This column "Cool Hand Luke" is written by Luke Verghese. Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.

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