Merck KGaA: Sole survivor

Bayer, Hoechst, ICI, Rhône-Poulenc, Solvay, and other European corporate giants broke their drug and chemical businesses into separate firms in the name of progress and shareholder value. Today, Darmstadt, Germany-based Merck KGaA is the only major European company making both chemicals and pharmaceuticals.

Merck’s performance materials business, featuring its chemical activities, posted a decline in sales last year, putting pressure on the company to take action. In 2014, facing similar conditions, Bayer decided to sell off its MaterialScience business, ending 150 years of industrial chemical production at the company.

While some Merck watchers might consider it time for a breakup there as well, the firm’s chief executive officer, Stefan Oschmann, made clear at its recent financial results briefing that he intends to keep the business together. Merck is different, Oschmann said, and he expects unique synergies between its businesses to emerge with the digitization of health care.

The sales slip in performance materials aside, the firm’s strategy seems to be working. At the event, Merck reported that 2016 sales were up 17% to $15.3 billion. Net income was up 45% to $1.7 billion. Health care generated 45.5% of the company’s sales, followed by life sciences—which incorporates the former Sigma-Aldrich business—with 38.0% of sales, and performance materials, including electronic materials, with 16.5%.

Merck has pursued a multibusiness strategy throughout most of its 349-year history. The approach really took off in 1827 when Heinrich Emanuel Merck built the firm’s first factory for supplying drugs to pharmacists.

A key difference between Merck and the companies that decoupled pharma and chemical businesses is that Merck remains more than 60% owned by the Merck family. And, to date, the family has had a longer-term outlook than the typical financial analyst does.

Sales for the performance materials business fell 1.8% in actual terms and 4.7% excluding acquisitions, while the other businesses grew. “But if you take a 20-year horizon, as the Merck family does, the business cycles for chemicals and pharmaceuticals offset each other quite nicely and together provide a steadier level of income,” said Brian McGee, pharmaceutical industry strategist for the London-based consulting firm Novasecta.

Walter Galinat, head of the performance materials business, seconded that notion. “The Merck family does what all families do when they invest: They spread the risk,” said Galinat, a 41-year veteran of the firm. “From the first day, they haven’t taken advice from analysts to focus solely on health care.”

In fact, Oschmann is convinced that now is the time when Merck’s unique structure will give the firm a real competitive advantage.

“We are the only science, innovation, and technology company in the world with expertise in laboratory materials and services, medicines, and electronics,” he said at the financial briefing. “These businesses must make sense themselves. But more and more, there is a convergence of laboratory services, electronic materials, and medicine. So for this reason we consider we are in a very good state.”

An example is Merck’s kits for CRISPR gene editing, which were created with expertise from throughout the firm. “We think this will be very important,” Oschmann said.

To support its approach, Merck is funneling money via its Merck Accelerator venture capital fund into early-stage start-ups that cross between health care and electronic materials.

Among them are Peach, a start-up, launched by individuals who attended a Merck brainstorming event in Ghana, that is developing a cloud-based medical records system; ATR Elements, a Munich-based firm making a silicon crystal-based infrared spectrometer for low-cost blood tests; and RxAll, a Connecticut company developing an artificial intelligence platform that will enable pharmacies to identify counterfeit drugs.

Each start-up receives up to $54,000 as well as office space, mentoring, and coaching in Merck’s innovation centers in either Nairobi, Kenya, or Darmstadt.

Oschmann expects the Internet of Things—the connection of machines and objects to the internet—to provide a raft of future business opportunities. “The sensor materials we are currently developing will provide an important basis for this development,” he said. “Think, for example, of the fully digitalized laboratory on which our colleagues in life sciences are currently working. Labs like these will be able to free scientists from administrative tasks and give them more time for their real work of research.”

Novasecta’s McGee is unconvinced of a strong near-term overlap between Merck’s electronic materials and health care businesses. “Given the human factors surrounding change in health care delivery, I see the emergence of mainstream sensors and bioelectronics as being many years away,” he says. “But Merck is well positioned when it does happen.”

As Merck defends its structure, it helps that all the company’s businesses are doing fairly well and have good pipelines of new products. Oschmann plans to continue boosting R&D spending. “R&D costs in the company are set to rise in 2017,” he said. “We can say that research costs will increase significantly. We think this is about confidence in our future.”

In pharmaceuticals, the company’s pipeline includes oncology and immunotherapy compounds and gene therapy treatments based on viral vectors. The firm has several new chemical and biological entities in Phase II or III trials.

One of Merck’s big hopes is the immunotherapy M7583, a highly selective inhibitor of Bruton’s tyrosine kinase, which plays a role in the functioning of immune cells. M7583 is in Phase II trials for treating hematological malignancies, systemic lupus erythematosus, and multiple sclerosis.

But the firm has given up on copycat biopharmaceuticals—so-called biosimilars—and has put this precommercial business up for sale.

Merck’s fastest-growing business is life sciences, which includes lab chemicals and contract manufacturing activities. Bolstered by the 2015 acquisition of Sigma-Aldrich, it posted organic sales growth last year of 6.3%. Integrating the Sigma-Aldrich business has delivered synergies more quickly than was anticipated, Oschmann said.

Merck’s performance materials business, featuring electronic chemicals, liquid crystals, and pigments, is the underperformer of the firm’s three divisions. Merck commercialized liquid crystals in 1904 and still commands a more-than-60% global market share.

Liquid crystal sales volumes declined in the past year, but the performance materials business’s pretax profit margin was down only slightly to a healthy 44%, still higher than that of Merck’s other two businesses. “The materials business, I think, has justified its place in the portfolio,” Galinat said.

In performance materials, Merck is betting on its coming rollout of printable organic light-emitting diodes (OLEDs). Seen as a successor to liquid crystals, OLEDs can be used to create superthin displays with applications in areas such as advertising. But getting costs low enough has been difficult and has hampered market introduction.

In association with the printer firm Epson, Merck developed a low-cost process that applies OLEDs in the same way as ink. “We already have good results and are striving for a breakthrough in mass production,” Galinat said. “It is about fine-tuning—not a problem of chemistry but the subtleties of applying a material.”

Merck will enter its 350th year as the only major western chemical-pharmaceutical company. But business conditions around the world are arguably more challenging than ever. Should chemical sales continue to decline, or synergies between businesses fail to materialize, the Merck family’s faith in its chemical business could face its sternest test.