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Merck KGaA Seeks Fix for ‘Bunker’ Culture to Woo Investors

Merck KGaA Seeks Fix For Bunker Culture to Woo Drug Invest
Merck traces its roots to 1668, when Friedrich Jacob Merck acquired a pharmacy in Darmstadt. Photographer: Hannelore Foerster/Bloomberg

Merck KGaA Chief Financial Officer-designate Matthias Zachert may make his first task repairing the German company’s relationship with investors and analysts as he seeks to revive one of Europe’s worst-performing drug stocks.

Morgan Stanley’s Andrew Baum last month questioned Merck’s ability to develop new drugs and wondered why it didn’t give up on the business. Sanford C. Bernstein & Co.’s Jack Scannell in October said the company’s American investor-relations representatives left more frequently than at other drugmakers. Executives haven’t been as open and available as investors would like, Ulrich Huwald of MM Warburg Investment Research said.

“Merck’s investor relations were strange,” Scannell, who has covered the company since 2006 and rates the shares “market perform,” said in a telephone interview. “The individuals in IR tried to be helpful, but it was as if they were locked in a bunker away from the rest of the business. So, for example, if you had a question that they had not answered before, it could take a very, very long time to get an answer.”

Turning around that perception may help Merck’s stock recover some of the ground it’s lost in the past five years. Shares of the drug and chemical company have fallen 11 percent including reinvested dividends, compared with a 2.1 percent drop in the Bloomberg European Pharmaceutical Index. Chief Executive Officer Karl-Ludwig Kley promised analysts last month he would personally work to improve the company’s communication.

Rebuilding Credibility

Kley surprised analysts in January by calling them individually. The company on Jan. 1 brought in a new head of pharmaceuticals and on Jan. 25 said Chief Financial Officer Michael Becker, 62, would retire after 11 years and be replaced by Zachert, the 43-year-old finance chief at Lanxess AG, a German chemical company. Zachert will join Merck by June 1.

“Clearly we are in a position of trying to rebuild credibility,” Joshua Young, head of investor relations at the Darmstadt, Germany-based company since November, said in a telephone interview. “In the course of 2011, we hope to take steps to do that.”

The stock rose 37 cents, or 0.6 percent, to close at 66.34 euros in Frankfurt trading today. Merck sells for 9.2 times estimated profit, compared with an average of 16.7 for global competitors of similar size.

Merck traces its roots to 1668, when Friedrich Jacob Merck acquired a pharmacy in Darmstadt. Its New York subsidiary became independent in the confiscation of German properties after World War I, and now Merck KGaA and Merck & Co. of the U.S. have no connection other than sharing a similar name.

Merck Family

Merck & Co. has grown to a market value of $102.6 billion, dwarfing Merck KGaA’s 14.4 billion euros ($19.9 billion). The German company is 70 percent owned by the Merck family through the parent company E. Merck KG. The roughly 130 family members choose representatives who hire, fire and set compensation for company executives, according to the company’s website.

Family ownership doesn’t insulate the company from the effect of poor communication, said Cornelia Thomas, a London-based analyst for WestLB AG, who rates Merck’s shares “reduce.” “People do get ticked off if the company doesn’t properly communicate,” she said in a telephone interview.

The most pronounced example was Feb. 23, 2010, the day Merck released its 2009 earnings, Thomas said. The stock opened down 6.2 percent after the company surprised investors with disappointing earnings and a reduced dividend.

“During the analysts’ meeting that day the share dropped another 3 percent to 4 percent, at least partly because they weren’t answering questions,” she said. The stock finished the day with a drop of 10 percent.

Erbitux Rejected

Merck began to lose credibility in July 2009, when European regulators rejected its cancer drug Erbitux for use in lung tumors, said Odile Rundquist, a Geneva-based analyst for Helvea SA, who rates Merck’s shares “neutral.”

In November 2009, U.S. regulators said the company’s application for the multiple sclerosis pill cladribine, at the time its most promising experimental medicine, wasn’t complete. In September, the European Medicines Agency rejected the drug. This month, the treatment failed again to win FDA backing.

Before the setbacks, the company’s former head of pharmaceuticals, Elmar Schnee, told analysts he was confident the company would be able to bring the products to market.

“Schnee would make persistently optimistic noises but not explain the reason for his optimism,” Bernstein’s Scannell said. “And then lo and behold, the FDA or EMA would turn the product down.” Merck replaced Schnee with Stefan Oschmann, formerly head of emerging markets at Merck & Co. Efforts to reach Schnee were unsuccessful.

Buying and Selling

The family has run Merck like a combination of a drug and chemical maker and a private-equity firm that makes money buying and selling businesses, Scannell wrote in a report last year. Merck acquired Swiss drugmaker Serono SA in 2007 for 16.6 billion francs ($17.9 billion) and bought Millipore Corp., a U.S. supplier of materials and equipment to biotechnology companies, for $6 billion last year. Merck sold its generic-drug unit to Mylan Inc. for 4.9 billion euros in 2007.

Beyond communicating better, the company needs to revive its drug business, Scannell said. Merck doesn’t have an experimental medicine close to market with significant sales potential, so the company may need to invest, possibly through another acquisition, he said.

Morgan Stanley’s Baum suggested last month the company should consider quitting the pharmaceutical business. It’s unlikely the Serono drug unit will earn a return on its investment in research that exceeds the cost of capital, Baum, who rates the shares “underweight,” wrote in a note last month.

Merck Pipeline

He told executives at a conference he was “perplexed” by the decision to invest $65 million in a drug-research site near Boston, “given the lack of anything really coming out of Merck research labs for decades.”

Kley conceded that “little has come out of the Merck pipeline over the last years,” and said a research network in the U.S. may help the company’s output.

Zachert help restructure Lanxess during seven years as CFO and did a “good job” at communicating with investors, Deutsche Bank AG analysts said in a Jan. 25 report. Lanxess shares have more than tripled since the company was spun off from Bayer AG in 2005. He’s likely to influence Merck’s strategy as well as the way it communicates with markets, said MM Warburg’s Huwald, who rates Merck’s shares “buy,” in a telephone interview.

“Clearly Merck has to do something, not only in communication,” Huwald said. “It’s a good sign that Zachert is joining.”

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