QUIC RESEARCH REPORT

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QUIC RESEARCH REPORT

QUIC Research Reports focus on

emerging investment themes that

affect current portfolio companies

and companies under coverage.

Consumers & Healthcare

Introduction

With the market for immuno-oncology and biopharmaceuticals

expected to generate significant growth over the next few years, we

believe that now is a good time to add another biotech name to our

portfolio.

Condensed Summary

- Merck is a market leader in the rapidly growing immuno-oncology

and Hepatitis C fields

- Merck is attractively valued relative to comps, and exhibits strong

growth potential

- Merck has one of the largest and most developed drug pipelines,

specifically for immuno-oncology drugs

- Merck is also making innovative developments with its new

Hepatitis C drugs

- We believe that adding Merck to our portfolio will help strengthen

our portfolio by exposing us to the lucrative biotechnology space

Merck & Co. Stock Pitch

A healthy addition to US Portfolio

August 17th, 2015

Daniel Morris

Julie Vincent

Jon Allion

Simon Rezene

QUIC Research Report

August 17th, 2015

Merck:

August 17th, 2015

Table of Contents

Introduction 1

Industry Overview 3

Industry Competitors 4

Company Overview 5

Investment Thesis I – Positioning for Immuno-oncology Exposure 6

Investment Thesis II – Rapidly Advancing Pipeline 7

Investment Thesis III – Attractive Entry Point 8

Catalysts and Risks 9

Valuation 10

References 13


August 17th, 2015

Merck:

August 17th, 2015 3

Industry Overview

2014 was a pivotal year for the healthcare industry,

with a significant increase in M&A activity as well as

an increased focus on research and development of

complex drugs. This momentum has continued into

2015 with numerous multi-billion dollar takeovers

and individual drug companies investing heavily in

their pipelines.

Right now, the industry is changing because of the

implementation of the Affordable Care Act (Obama

Care). Although this will not directly impact

pharmaceutical company in terms of their ability to

innovate, it will increase prescription sales and visits

to medical practitioners. AS more individuals are

covered, healthcare spending will increase

benefitting pharma companies and biotech

companies alike. However, there is some fear that if

the government becomes a large purchaser of

healthcare products, this could result in increased

price controls.

The first major trend in the industry is Immuno-

Oncology and immuno-therapies. Immuno-

oncology is a new and revolutionary form of cancer

treatment. It targets the immune system as a whole,

instead of targeting specific tumour cells like

traditional cancer therapies do. Immuno-therapy

drugs allow the immune system to recognize and

attack cancerous cells which, over time, activates

the immune system’s long-term memory.

This enables the body to continuously fight

cancerous cells, should cancerous cells relapse.

The second trend is bio-printing. Bio-printing allows

for the creation of three-dimensional tissues and

organs which can be used to replace damaged

tissues or cells. Bio-printing works by combining

cultured human cells and a liquid gel known as

“bio-ink” to create layers of human cells

interspersed in hydrogel. Once the tissue has been

printed, it is left to grow naturally and the hydrogel

is removed. Scientists have found that this can help

to reverse degenerative diseases and leads to a

faster recovery for patients with internal ailments.

Many pharmaceutical firms are also looking at bio-

printing as a way of speeding up clinical trials and

lowering their costs of development and testing.

Bio-printing would allow companies to test the

effects and toxicity of drugs, reducing liability of

pharmaceutical firms as well as allowing the firm to

determine whether the drugs are worth being put

through costly clinical trials.

Going forward, we expect pharmaceuticals and

biotech companies to continue converging, leading

to more breakups and spinoffs. Eventually, we see

this leading to drug companies focusing on smaller

niches and pharmaceutical companies focusing on

sustainable growth opportunities and innovation.

Currently Available

•Robotic interventions in surgeries

•Smart watches

•Real-Time Diagnostics

• Inter-disciplinary therapies

In Progress / Available Soon

•Optogenetics

•Robotic Assistants

•Customized mobile health apps

•Artificial organs

•Embedded sensors

•3D printed Biomaterials and

Drugs

Still Needs Time

•Nanorobots in blood

•Augmenting Human Capabilities

•Home Diagnostics

•Gamification Based Wellness

•Full Physiological simulation

•Remote Touch

•Multi-Functional radiology

EXHIBIT 1

Innovation in the Healthcare Industry


August 17th, 2015

Merck:

August 17th, 2015

1 Year Expected Revenue Growth Market Share by Revenue

4

Industry Competitors

Company AstraZeneca BMS Eli Lilly Novartis Pfizer Merck

EV ($MM)

$90,904 $107,248 $92,803 $258,175 $223,376 $182,107

Market Cap ($MM)

$84,413 $105,186 $88,997 $241,759 $217,831 $166,688

2014A Revenue

($MM)

$25,237 $16,383 $19,620 $51,724 $48,196 $40,249

EBITDA Margin19% 20% 23% 33% 39% 58%

Operating Segments Cardiovascular and

Metabolic

diseases;

Oncology;

Respiratory,

Inflammation and

Autoimmunity,

Infection,

Neuroscience and

Gastrointestinal

Cardiovascular,

Virology,

Oncology,

Neuroscience,

Immunoscience

, Metabolics

Human

pharmaceuti

cal products

and animal

health

products

Pharmaceutical

s, Alcon

(eyecare),

Sandoz

(generic

diagnostics)

Global

Innovative

Pharmaceutical,

Global

Vaccines,

Oncology and

Consumer

Healthcare and

Global

Established

Pharmaceutical

Pharmaceu

tical,

Animal

Health

Main Drugs Crestor,

Seloken/Toprol-XL,

Faslodex

Baraclude, HCF

Franchise,

Reyataz

Humalog,

Alimta, Cialis

Diovan, Glivec,

Lucentis

Prevnar, Lipitor,

LyricaJanuvia,

Zetia,

Keytruda

0%

2%

4%

6%

8%

10%

12%

AZN BMS LLY NOVN PFE MRK

$51,724

$48,196$40,249

$25,237

$19,620

$16,383

NOVN PFE MRK AZN LLY BMS


August 17th, 2015

Merck:

August 17th, 2015

Merck serves as a global healthcare provider,

delivering innovative health solutions through its

prescription medicines, biological therapies,

vaccines and consumer & animal health products.

The is split into major divisions consisting of heart

and respiratory health, women’s health and

infectious diseases. Merck was founded in 1891 and

is currently headquartered in Kenilworth, New

Jersey. The company is led by CEO Kenneth Frazier

and in 2015 generated more than $42 billion in

revenues.

Merck is propelled by a strong research and

department division which has led to the approval

of 63 drugs by the FDA as of August 2014 - more

than any other healthcare company. The

company’s products fall into the categories of

vaccines, prescriptions, oncology, consumer

products, animal health products and product

patents. Major products include Januvia, used to

treat type 2 diabetes, Zetia, taken to inhibit the

absorption of dietary cholesterol, Remicade, used

for the treatment of several autoimmune disorders,

Gardasil, a cervical cancer vaccine, Isentress, the first

anti-HIV compound of its kind, and Keytruda, an

immune modulator for the treatment of many

cancers.

Nearly half of Merck’s total revenues are generated

from the United States, with areas from the EMEA

and Asia Pacific also contributing for strong

portions of sales. As of 2014, the company had

operations in 120 countries and factories in more

than 30 factories across the world. The company’s

most recent acquisitions took place in 2014 when

Merck bought Idenix Pharmaceuticals for $3.85

billion and Cubist Pharmaceuticals for $8.4 billion.

The company is committed to creating value and

returning cash to shareholders as evident by the

company’s share repurchase and dividend plan

which has roughly doubled since 2010.

The company’s pipeline involves products in the

biologic, small molecule and vaccine categories.

Merck currently possesses thirty-eight programs in

either the phase II, phase III or under review stages.

Moving forward, the company sees growth

potential in the areas of diabetes, vaccines, hospital

acute care and oncology, and as a result has

focused the future of its R&D strategy in these

divisions.

5

Company Overview

Major Products by Patent Expiration Date

EXHIBIT 4

EXHIBIT 5Merck Geographic Segmentation 2014A

Source: Company Reports

Source: Thomson Reuters

40%

31%

9%

8%

7%3% United

States

EMEA

Asia Pacific

Japan

Latin

America

Other

Product Year of Expiration

Zetia 2017

Januvia 2022

Isentress 2023

Gardasil 2028

Keytruda 2028

Remicade Patent Rejected


August 17th, 2015

Merck:

August 17th, 2015 6

Investment Thesis I: Positioning for Immuno-oncology Exposure

Merck is recognized for their market leadership in

the fastest growing sector in US healthcare:

Immuno-Oncology. After years of research and

development, they have created the most

innovative pipeline, with the highest expected

success rate amongst their peers.

By 2020, the global oncology market is excepted to

reach approximately $112 billion. More specifically,

North America accounts for ~40% of total oncology

sales, and is estimated to be growing at an 8.7%

CAGR. The leading biotechnology firms are based in

the United States, which is currently struggling with

its population structure. The United States is

experiencing an increase in the number of

individuals aged 65+, resulting in an increased

strain on the healthcare system. 63% of all deaths in

the United states result from chronic diseases, with

cancer being the most prevalent). Therefore, the

market for immuno-oncology drugs will continue to

increase.

Recently, Merck acquired a small biotech company

specializing in immuno-therapies called cCam

Biotherapeutics. They are currently in late stage

development of a drug targeted at late stage

cancers, which is so far showing promise. Should his

drug be approved by the FDA, this could result in

large revenue gains for Merck.

Moreover, Merck’s blockbuster immuno-oncology

drug Keytruda has performed extremely well for the

company. Keytruda is known to treat lung cancer of

differing severities far more effectively than

chemotherapy can. Although the drug is extremely

expensive, the company is working on ways to

lower the price in order to allow distribution of the

drug to the maximum number of individuals

possible. Once this is possible, immuno-therapies

will be the new standard in cancer treatment.

EXHIBIT 2

Melanoma

Lung

RCC

Colorectal

Solid Tumors

Hematologic

Merck & Co. Immuno-Oncology Pipeline

Pre – Clinical Phase I Phase II Phase 3 Approval


August 17th, 2015

Merck:

August 17th, 2015 7

Merck’s best in class research and development

program has allowed for an advanced pipeline with

many drugs being processed in all regulatory

stages. The company currently has 13 programs in

phase II (2 advanced), 19 programs in phase III (1

advanced) and 6 programs under review (2

advanced). Merck’s pipeline consists of candidates

in a wide range of disease areas spanning from

atherosclerosis, cancer, cardiovascular diseases,

diabetes, infectious disease, autoimmune diseases,

neurodegenerative diseases, osteoporosis,

respiratory diseases and women’s health.

During 2014, Merck continued to execute on its

strong R&D program through the acceptance of six

products in the USA, granted by the Food and Drug

Administration (FDA). Product approvals included

Keytruda, Belsomra and Gardasil 9. The company

also built its pipeline though acquisitions of Idenix

Pharmaceuticals, OncoEthix and Cubist

Pharmaceuticals. In January of 2015, the company

partnered with Bayer to develop and market novel

therapies for cardiovascular diseases and other

therapeutic indications.

Merck’s largest focus for research and development

currently is tied to the company’s Keytruda

program, designed to cure several cancers. In June

of 2014, Merck announced that the FDA had

granted accelerated approval of Keytruda at a dose

of 2 mg/kg every three weeks for patients with

metastatic melanoma. The Keytruda clinical

development program also includes studies across

a broad range of cancer types including breast,

bladder, lung, stomach, Hodgkin Lymphoma and

head and neck. As of 2012 data, these cancers are

known to be some of the most common across the

globe.

Moving forward, Merck is committed to making

externally sourced programs a greater component

of its pipeline strategy. The company is focused on

a renewed focus on supplementing its internal

research through licensing and an external alliance

strategy focused on the entire spectrum of

collaborations from early research, late-stage

compounds and new technologies.

Investment Thesis II: Rapidly Advancing Pipeline

EXHIBIT 8

Merck Product Pipeline Breakdown

Source: Company Reports

EXHIBIT 9

Top 5 Most New Cancer Cases Diagnosed 2012A (1000s)

Source: World Cancer Research

0

10

20

Phase II Phase III Under Review

Programs in Development Advanced Programs

0 500 1,000 1,500 2,000

Stomach

Prostate

Colorectal

Breast

Lung

Products in Merck Pipeline

Products not in Merck Pipeline


August 17th, 2015

Merck:

August 17th, 2015 8

Investment Thesis III: Attractive Entry Point

EXHIBIT 10

Relative Performance

Source: Capital IQ

EXHIBIT 11

Historical LTM EV/EBITDA

Source: Capital IQ

86

96

106

116

126

136

146

156

166

176

02-Jan-14 02-Jun-14 02-Nov-14 02-Apr-15

MRK S&P/TSX Capped Healthcare Index S&P 500 PFE BMS

10.0x

10.5x

11.0x

11.5x

12.0x

12.5x

17/08/2014 17/11/2014 17/02/2015 17/05/2015 17/08/2015

The Consumers and Healthcare team believes

Merck is currently undervalued relative to its peers

because it’s been able to successfully engage in

expanding its immune-oncology segment. The

growing trend towards oncology treatment has

resulted in high valuations among other players.

Merck’s immune-oncology program is currently

exploring 30+ different tumor types and 40+

different combos but with primarily with proven

but non-proprietary assets or are untested with

Keytruda. With that being said, the continued

success of Merck’s oncology drug, Keytruda, proves

now to be a great buying opportunity. The drug

has recently been approved in the European Union

and is currently under FDA priority review. The

team believes the market will continue to discount

solid Keytruda data, and Merck’s growing oncology

segment.

In addition, Merck has an attractive pipeline (e.g.

Odanacatib, Anacetrapib, BACE inhibitor) that

supports long-term growth.


August 17th, 2015

Merck:

August 17th, 2015 9

Catalysts & Risks

Catalysts

1. 1. Hepatitis C Launch: Prior to releasing Q2

2015 earnings, Merck announced that the Food

and Drug Administration accepted the

company’s New Drug Application and granted

priority review for grazoprevir/elbasvir with a

target action date of January 28, 2016. The

once-daily single-tablet pill is used for the

treatment of adult patients chronically diseased

with genotypes 1, 4, or 6 HCV. The data for

evaluation is from C-EDGE, C-SURFER and C-

SALVAGE clinical trials. The launch is expected

to run through FY 2016.

2. cCAM Acquisition – On July 28, 2015 Merck

announced a signed definitive agreement

under which the company will acquire cCAM

Biotherapeutics, a privately held

biopharmaceutical company focused on the

discovery and development of novel cancer

immunotherapies. Based on the terms of the

agreement, Merck will acquire all outstanding

shares of cCAM for $95 million in cash. The

move is seen as a play by the company to

further enhance their immuno-oncology

pipeline and provides Merck with several early

immunotherapy candidates in early phases of

research and development.

Risks

1. Failure or any further delays of three key

pipeline products in the near future (Suvorexant,

Odanacatib and Cordaptive) could adversely affect

pipeline development and top line growth

2. Competitive threats stemming from increased

investment in immuno-oncology and HCV therapies

by industry peers could affect Merck current

dominant market share and growth prospects.

3. Failure to effectively manage the core

Januvia/vaccines portfolio, as patients who have

used in the drug in the past have filed lawsuits

against Merck.

4. As U.S. government becomes a regulatory body,

the implementation price control within the ACA

may induce a downward pressure on drug prices,

making pharmaceuticals more accessible. Any price

setting by the government would impact revenues

for large pharmaceutical firms.


August 17th, 2015

Merck:

August 17th, 2015 10

Comparables

Analyst Target Prices

Valuation

As evident by the comparables chart above, Merck is trading at a discount compared to its peers on a

price/earnings basis. Although EPS growth is milder for Merck than other companies in the universe, the

company has a dividend yield that is well above the industry average. Finally, on an EV/EBITDA basis Merck

is trading below its peers, displaying the opportunity for strength growth potential moving forward.

$63.00

$64.00

$65.00

$67.00

$66.66

$68.00

$72.93

$55.00 $60.00 $65.00 $70.00 $75.00

Evercore

Barclays

PiperJaffray

Leerink

Consensus

UBS

QUIC

Company Name Market Enterprise P/CFPS Dividend

Cap ($MM) Value ($MM) 2015E 2016E 2015E 2016E 2015E 2016E 2015E 2015E 2016E Yield

Johnson & Johnson $276,551 $261,904 11.1x 10.2x 16.2x 15.6x 6.2% 6.4% nmf 3.6x 3.7x 3.0%

Pfizer Inc. $218,941 $224,172 10.7x 9.9x 17.1x 15.3x 2.1% 2.3% $0.08 4.7x 4.7x 3.2%

Gilead Sciences Inc. $170,859 $174,522 10.4x 9.7x 10.0x 10.1x 11.7% 11.5% $0.26 6.0x 2.3x -

Amgen Inc. $128,743 $98,750 8.9x 8.1x 17.4x 15.9x 9.7% 10.7% nmf 4.8x 4.6x 1.9%

UnitedHealth Group Incorporated $118,070 $126,372 9.7x 8.3x 19.6x 16.9x 6.3% 7.3% $0.14 0.9x 0.7x 1.7%

AbbVie Inc. $114,827 $106,548 10.4x 8.9x 16.3x 13.8x 4.3% 5.0% $0.14 3.8x 4.3x 3.0%

Medtronic plc $111,353 $128,120 12.8x 11.9x 18.0x 16.3x 4.4% 4.8% $0.48 6.4x 4.5x 2.0%

Bristol-Myers Squibb Company $105,836 $107,730 28.1x 22.6x 34.8x 28.2x 1.8% 2.3% $0.86 6.6x 6.9x 2.3%

Mean $155,647 $153,515 12.8x 11.2x 18.7x 16.5x 5.8% 6.3% $0.33 4.6x 4.2x 2.4%

Median $123,407 $127,246 10.6x 9.8x 17.3x 15.7x 5.3% 5.7% $0.20 4.7x 4.5x 2.3%

Merck & Co. Inc. $168,181 $183,410 10.2x 10.1x 17.1x 15.6x 3.5% 3.8% $0.17 4.6x 4.577 3.0%

EV / EBITDA Price / Earnings EPS Growth EV / Sales


August 17th, 2015

Merck:


Comparables

We value Merck using a discounted cash flow

model. The cost of equity is derived using the

Untied States 10-year treasury yield of 2.36% and a

market risk premium taken from Professor

Damodaran’s 2015 U.S estimate. Cost of debt is

calculated using a weighted average yield of

Merck’s outstanding debt. WACC was calculated to

be 3.55% based on these estimates. Combined with

an assumed terminal growth rate of 1.5% resulted

in a target share price of $72.93, an implied 26.7%

total return after dividends.

Valuation

WACC Calculation

Risk-Free Rate 2.36%

Market Risk Premium 5.78%

Levered Beta 0.39x

Cost of Equity 4.64%

Cost of Debt 2.79%

Tax Rate 35.00%

After Tax Cost of Debt 1.81%

Capital Structure

Debt 39%

Equity 61%

Total: 100%

WACC 3.55%

Share Price Calculation

PV of UFCF 27,160

Terminal Year Growth Rate 1.50%

Discount Rate 3.55%

PV of Terminal Value 204,358

Enterprise Value 231,518

Enterprise Value 231,518

Less: Total Debt 30,248

Plus: Cash and Cash Equivalents 7,980

Implied Equity Value 209,250

Shares Outstanding 2,869

Implied Share Price $72.93

Current Price $59.00

Target Price $72.93

Dividend Yield 3.1%

Total Return 26.7%

Discount Rate (%)

$72.93 2.55% 3.05% 3.55% 4.05% 4.55%

0.50% 78.69$ 60.88$ 48.99$ 40.50$ 34.16$

1.00% 103.95$ 75.66$ 58.54$ 47.10$ 38.94$

1.50% 153.29$ 99.96$ 72.75$ 56.29$ 45.30$

2.00% 292.32$ 147.41$ 96.13$ 69.97$ 54.14$

2.50% 3,212.04$ 281.14$ 141.78$ 92.47$ 67.30$

Term

inal

Gro

wth

(%

)


August 17th, 2015

Merck:


Appendix: Discounted Cash Flow

Historical Period Projection Period

2011 2012 2013 2014 2015 H1 2015 H2 2016E 2017E 2018E 2019E

Revenue

Pharmaceutical 41,289 40,601 37,437 36,042 17,636

Other 6,428 6,412 6,325 5,585 1,803

Corporate 330 254 271 610 468

Total Revenues 48,047 47,267 44,033 42,237 19,907 19,754 41,207 41,247 42,917 44,673

Year over Year Growth % (1.6%) (6.8%) (4.1%) (5.7%) (6.5%) 3.9% 0.1% 4.1% 4.1%

Cost of Goods Sold 16,871 16,446 16,954 16,286 7,108 7,590 14,653 14,254 14,402 14,545

% of Revenue 35.1% 34.8% 38.5% 38.6% 35.7% 38.4% 35.6% 34.6% 33.6% 32.6%

Gross Profit 31,176 30,821 27,079 25,951 12,799 12,164 26,555 26,993 28,515 30,128

Margin % 64.9% 65.2% 61.5% 61.4% 64.3% 61.6% 64.4% 65.4% 66.4% 67.4%

Operating Expenses 23,506 21,608 21,123 19,799 7,108 11,742 20,264 21,089 22,210 23,657

% of Revenue 48.9% 45.7% 48.0% 46.9% 35.7% 59.4% 49.2% 51.1% 51.8% 53.0%

EBITDA 7,670 9,213 8,740 6,132 5,691 422 6,290 5,903 6,305 6,471

Year over Year Growth % 20.1% (5.1%) (29.8%) 85.6% (86.2%) 2.9% (6.2%) 6.8% 2.6%

Less: Depreciation and Amortization 7,427 6,978 6,608 6,691 2,977 3,078 6,291 6,297 6,552 6,820

% of Revenue 15.5% 14.8% 15.0% 15.8% 15.0% 15.6% 15.3% 15.3% 15.3% 15.3%

EBIT 243 2,235 2,132 (559) 2,714 (2,656) (1) (394) (248) (349)

Year over Year Growth % 0.0% 819.8% (4.6%) (126.2%) (1070.7%) 850.0% (102.0%) 33253.0% (37.1%) 41.0%

Less: Income Taxes 942 2,440 1,028 5,349 4,907 (4,887) (0) (138) (87) (122)

Effective Tax Rate 387.7% 109.2% 48.2% (956.5%) 180.8% 35.0% 35.0% 35.0% 35.0% 35.0%

Net Operating Profit After Taxes 699- 205- 1,104 (5,908) (2,193) 2231 -1 -256 -161 -227

Year over Year Growth % (70.7%) (638.6%) (635.1%) 71.1% (100.6%) (102.0%) 33253.0% (37.1%) 41.0%

Plus: Depreciation and Amortization 7,427 6,978 6,608 6,691 2,977 3,078 6,291 6,297 6,552 6,820

Less Capital Expenditures (1,723) (1,954) (1,548) (1,317) (693) (698) (1,443) (1,420) (1,437) (1,515)

% of Revenue 3.6% 4.1% 3.5% 3.1% 3.5% 3.5% 3.5% 3.4% 3.3% 3.4%

Less: Change in Net Working Capital (332) (729) (169) 3,460 (2,552) 3,110 558 558 558 558

Unlevered Free Cash Flow 4,673 4,090 5,995 2,926 (2,461) 7,720 5,405 5,179 5,512 5,636

Discount Period 0.5 1.5 2.5 3.5 4.5

Discount Factor 98.1% 94.5% 90.9% 87.5% 84.3%

Present Value of Unlevered Cash Flows 7,575 5,105 4,709 4,824 4,749


August 17th, 2015

Merck:

August 17th, 2015

References

13

1. Company Reports

2. Bloomberg

3. Thomson Reuters

4. Capital IQ

5. Globe and Mail

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