Par Aims To Add Branded Products After Merck KGaA Divests Equity Stake

Par is looking to add branded products to its portfolio as it seeks to join the top-tier independent generic drug companies after Merck KGaA divests its controlling interest in the firm.

Merck announced Aug. 22 that it would sell its 43% stake in Par-parent Pharmaceutical Resources via a private placement to 53 institutional investors.

Par's goal is to continue operations as an independent company, with its near-term strategic plan being to in-license branded products.

Par will consider products that are currently being marketed, the company said. The company has not initiated discussions so far with any pharmaceutical company on buying branded products, but hopes to complete its first agreements in 12 to 18 months.

In addition Par will "expand its internal R&D capability and eventually reduce its reliance on alliance partners, resulting in increased gross margin," the company said.

The proposed Merck sale will restore Par to complete independence during a period of consolidation in the generic drug sector.

With the large block of shares dispersed among a broader group of investors, Par will have a greater degree of control over its strategic direction. Merck KGaA's equity position allowed it to appoint a majority of Par's seven member board of directors. The four Merck directors will resign following completion of the sale, to be replaced by outsiders selected by Par.

Par said that it believes the current round of consolidation in the generic sector is over.

Barr expects its proposed $500 mil. acquisition of Duramed to close by Nov. 1, while Alpharma is in the process of completing its $600 mil. acquisition of Purepac, Faulding's generic oral pharmaceutical business (¹ (Also see "Duramed Verapamil Production Resumption Expected Within Several Months" - Pink Sheet, 13 Aug, 2001.)).

Mylan recently denied rumors that it is a target for acquisition (² (Also see "Mylan merger speculation" - Pink Sheet, 2 Jul, 2001.)).

With a market capitalization of just over $1 bil., Par would be a costly takeover target for other generic firms. However, the company is carrying a significantly lower value than the top-tier of publicly traded generic companies, including Teva (over $9 bil.), Ivax ($7 bil.), Watson ($6 bil.), Mylan ($4 bil.) and Barr ($3 bil.).

A successful expansion into branded products could help Par close that valuation gap: each of the larger firms has branched out into the branded sector.

Merck's decision to use a private placement to divest its stake in Par suggests that there is not a strong interest in an acquisition of the company at a premium price.

It also suggests that Merck was interested in a relatively quick transaction, rather than going through the potentially prolonged negotiations and antitrust review involved in a sale to a competitor.

Merck's decision to sell its share of Par was not initiated in-house and was completed rapidly, a Pharmaceutical Resources filing with the Securities & Exchange Commission indicates. Merck was approached by Bear Stearns in July "to determine whether KGaA would be interested in selling all or part of" its shares in Par, the filing states.

In response, KGaA said that if it "were to receive offers to purchase all of the shares" on good terms, then it would agree to sell its stake in Par.

Following discussions with "a limited number of institutional investors," Bear Stearns "informed KGaA that while no firm offers to purchase the KGaA shares had been received...offers could be forthcoming," the filing states. Bear Stearns presented Merck with the offers on Aug. 21.

Bear Stearns acted as principal placement agent in the transaction, with Boston-based Leerick, Swann & Co. as subplacement agent. Bear Stearns will receive approximately 4.5% of the gross proceeds from the sale of stock by the company to the institutional investors, the filing indicates.

The transaction will not end Merck's involvement in the U.S. generic business, or its business relationship with Par. Merck's directly-owned subsidiaries GenPharm and Alphapharm will continue to supply products to Par, the generic company said.

Par markets 14 generic products under an agreement with GenPharm and is awaiting approval of 11 ANDAs. Four of the 11 ANDAs have received tentative approval. Par extended its agreement with GenPharm in November 2000 to include six additional products. One of those products is awaiting approval from FDA, Par noted.

One important product covered by the agreement is generic fluoxetine, which Par sells in 10 mg and 20 mg tablet formulations. Generic flecainide is another product covered by the GenPharm agreement.

Merck KGaA, however, may be reconsidering its direct generic presence in the U.S. as well.

"We are not really interested in generic competition because the margins are lousy," CEO Bernhard Scheuble, PhD, told analysts last year. "So let me say we are not completely satisfied with the development of our U.S. generic activity. We are looking for options to optimize that, because at the end of the day we would like a decent profitability of our generics business" (³ (Also see "Merck KGaA's Lindolrestat Expected To Move To Phase II In 2001" - Pink Sheet, 6 Nov, 2000.)).

Par also has a strategic distribution agreement with Dr. Reddy's. The April agreement covers 14 generic drugs, including fluoxetine 40 mg capsules. Both companies have indicated interest in expanding that relationship.

Dr. Reddy's recently completed a $115.5 mil. initial public offering in the U.S. The company set aside $90 mil. for acquisitions and expansion of its marketing base (⁴ (Also see "Dr. Reddy's Looks To Acquire U.S. Generics Company Following $115 Mil. IPO" - Pink Sheet, 16 Apr, 2001.)).

Merck acquired the stake in Par in March 1998 for $28 mil., less than one-tenth of the proposed sale price of $360 mil. ($27 per share). At the time of the Merck investment, Pharmaceutical Resources was one of the generic companies suffering most from price competition and declining profit levels in the industry sector as a whole.

Par has turned around from an operational standpoint at the same time that the generic industry is back in favor with investors. Par's net income for six months ending June 30 was about $4 mil. compared to a loss of $1.8 mil. during the previous year. Net sales in the first six months of 2001 were up 35% to $55 mil.

The number of pending patent expirations for blockbuster products, coupled with the potential for Congressional moves to encourage wider generic use, particularly under Medicare, have helped boost the market capitalization of all generic companies.

The timing of the transaction means that Merck will be receiving a nice payback from its investment in the generic sector, while at the same time bracing for a significant loss on the branded side.

Merck licenses Glucophage (metformin) to Bristol-Myers Squibb in the U.S., and generic competition to the antidiabetic is expected imminently.

The deal may also simplify Merck's relationship with Bristol. Par is one of the parties involved in the protracted patent litigation with Bristol over BuSpar. Par launched a 7.5 mg dose of buspirone after a federal appeals court denied Bristol's motion to stay the generic approvals, although an appellate ruling is pending (⁵ (Also see "Par 7.5 Mg Buspirone Aims To Capture Portion of 15 Mg Split-Tablet Market" - Pink Sheet, 2 Apr, 2001.)).

Par also recently won an appellate court decision that affirmed a summary judgment dismissing Bristol's Megace patent infringement suit against Par.

"Although the court has disposed of all infringement issues, Par's counterclaims for patent invalidity, unfair competition and tortuous interference remain," the company's most recent quarterly report says. "Par's counterclaims seek an injunction and an award of compensatory and punitive damages."

Par started marketing its generic megestrol suspension July 25. Par's generic is priced at a 40% discount to Megace, the company said. Par hopes to capture 50% of the megestrol suspension market within its 180 days of exclusivity.

The sale may also increase speculation about Merck's overall strategic direction by providing the company with enhanced cash reserves to pursue new ventures.

The German company said it would use the proceeds from the private placement to invest in its oncology franchise. In particular, the proceeds could free up resources for developmental projects in oncology.

Development of Merck's bispecific antibody H-447 for adjuvant and palliative treatment of head and neck tumors has been on hold due to a lack of resources.

Merck has two other oncology projects in Phase III via partnerships with biotech firms: the ImClone EGF receptor inhibitor monoclonal antibody and the Biomira Theratope cancer vaccine.