Merck Gilead Patent Trial 3/14/16

Client Attorney Privileged/Attorney Work Product/At Request of Counsel

Online Sources

1. Gilead And The $3 Billion Merck Issue

   Mar 17, 2016 | Seeking Alpha

   By Jonathan Weber
   
   
   Merck seeks a ten percent royalty fee from Gilead. The case is not clear, Gilead claims Pharmasset developed the component before Merck got its patent. Even in a worst case scenario Gilead would not be threatened and could easily cover the cash expenses with its $26 billion cash pile. Final decision on this case is very likely years away.

Full Text of Stories Below

Client Attorney Privileged/Attorney Work Product/At Request of Counsel

Online Sources

1. Gilead And The $3 Billion Merck Issue

   Mar 17, 2016 | Seeking Alpha

   By Jonathan Weber

   Gilead (NASDAQ:GILD) is very successful with its HCV drugs Sovaldi andHarvoni, which made Merck (NYSE:MRK) attack Gilead over patent issues with these drugs. Merck seeks a $3 billion payment from Gilead. Such a decision in court is not very likely, and even if Gilead was forced to pay, this wouldn't be a huge problem for the company.

   In 2002 Merck was awarded patent rights the company seeks to enforce now, claiming it deserves ten percent of Gilead's total HCV revenues derived from its drugs Sovaldi and Harvoni. Gilead, on the other hand, claims that development of its HCV drugs started in 2001, i.e. one year before Merck got its patent. Gilead thus believes it is not infringing on Merck's patent and will not agree to pay the $3 billion in question.

   In February a judge ruled that the case would go to court, the decision about potential royalty payments lies with a jury now. This jury would also decide on how high the royalty payments would have to be. There are several possible outcomes to this case:

   - The jury rules that the patent is not valid anymore -- Gilead would not be forced to make any payments at all, for past or future revenues of its HCV drugs -- this obviously is the best outcome for Gilead and its shareholders. A jury ruling that Pharmasset developed the drug on its own would be seen as a precedent for other possible patent claims by other companies, i.e. this would strengthen Gilead's claim that its drugs belong to Gilead solely.

   - The jury rules the patent as valid but decides the royalty payments should be less than ten percent (e.g. five percent of Gilead's past and future HCV revenues). This would mean a small hit to Gilead's current cash position (around $1.5 billion if the fee was five percent) and future payments of about $1 billion a year (assuming Gilead's HCV revenues remain around $20 billion a year). A small hit to Gilead's current cash pile and a small hit to Gilead's future earnings would be a negative for Gilead, but not a huge problem: With a very huge cash position and immense free cash flow generation Gilead would be easily able to fund these royalty fees.

   - The jury could decide that Merck's patents are valid and that Merck deserves ten percent of Gilead's HCV revenues. This would be a bigger hit to Gilead's earnings, but still not threatening for Gilead in any way. With its $26 billion in cash Gilead could cover the $3 billion royalty payment for its past HCV revenues, as well as cover the royalty payments for $230 billion in future HCV revenues, which would be more than ten years at the current HCV revenue run rate.

   Even in the worst case scenario Gilead would not be forced to lower its cash returns (via dividends and share repurchases) or its R&D investments, as the company's cash pile and huge free cash flows are high enough to cover any cash needs in addition to potential royalty payments to Merck. Gilead generated $19.6 billion in free cash flows in 2015, let's assume $20 billion in free cash flows for the current year. Should Gilead be forced to pay 10 percent of its HCV revenues to Merck, this would lower Gilead's operating earnings by $2 billion, and its net earnings by $1.7 billion (pre tax expenses of $2 billion mean after tax costs of $1.7 billion for Gilead), which would mean that operating cash flows -- and thus also free cash flows -- would drop by $1.7 billion as well. 2016's free cash flow number would thus be still around $18 billion -- enough to cover this year's dividend payments of $2.5 billion, $15 billion in share repurchases (enough to reduce the share count by twelve percent) and yet at the same time Gilead would still be able to grow its cash pile (which would be $23 billion after the $3 billion payment to Merck). We see that this issue does not mean any reduction for Gilead's shareholder returns or a threat to its cash pile.

   In reality a ruling against Gilead would lead to an appeal by Gilead, the issue would likely be in court for years before a final decision is made -- the thought experiment from above however shows that this wouldn't be a threat for the company even if Gilead did lose the case and not appeal against the decision. I thus believe that investors don't need to worry about this issue too much, since it is not especially likely that Gilead will lose, and even if the company lost the case this would not have a huge effect on Gilead's profitability and cash generation (and very likely not any effect at all for a couple of years, before the final ruling is issued).

   Merck is also targeting Gilead [as well as AbbVie (NYSE:ABBV)] in another way as well: Zepatier, Merck's HCV drug which got approved earlier this year, seeks to gain market share from Harvoni, Sovaldi and AbbVie's Viekira Pak. Since the drug is still very new to the market we can't say about its potential market share yet, Merck's next earnings call could give more information regarding Zepatier's success. I believe that Zepatier will not steal a lot of market share from Gilead's HCV drugs Harvoni and Sovaldi, but rather from AbbVie's Viekira Pak -- the drugs safety issues poise it to lose market share, whereas Harvoni and Sovaldi -- which have proven to be efficient and safe by curing hundreds of thousands of HCV patients globally -- are less likely to be replaced by Zepatier, since doctors know these drugs and have seen huge success in using these two to treat their patients.

   Takeaway

   Merck seeks to get $3 billion in royalty fees from Gilead, the case will be ruled by a jury. No matter who wins, appeals will very likely follow -- this issue will take years to be solved.

   Even in the worst case scenario Gilead would not be harmed a lot, the $3 billion payment is equal to about ten percent of Gilead's cash position, and even if annual payments would be made Gilead would very likely still generate about $18 billion in free cash flows each year -- more than enough to cover the company's shareholder returns. Investors need not to worry about lower share repurchases, smaller dividends or liquidity issues -- even when looking at the worst case scenario of Merck receiving ten percent of Gilead's HCV revenues.

   Disclosure: I am/we are long GILD.

   I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

   Return to headline | Return to top

Full Text of Stories Below