HIV drug signals new era for Merck

(Fortune) -- The Food and Drug Administration's approval of Merck's HIV medicine, Isentress, this afternoon punctuates the oft-overlooked resurgence of the drugmaker's research labs in the midst of top-management turnover, product liability lawsuits and industry-wide scientific malaise.

It's no secret to anyone that Merck (Charts, Fortune 500) and its hallowed research labs fell from grace in the fall of 2004, after studies suggested that its Vioxx painkiller caused heart problems. Hardly a paragraph could be written about the company without mention of "the V-word," as insiders call it. Merck is still battling through the lawsuits and will be for a while.

But in the three years since the Vioxx debacle, Merck has quietly been on a comeback. Although revenue growth has been stagnant in the midst of CEO Richard Clark's "roadmap" to recovery plan, Merck has released several promising medicines that should boost earnings in coming years. Of the seven medicines Merck has rolled out since fall of 2005, five (including Isentress) have been unique innovations. Those medicines include Gardasil, a vaccine to fight a cervical cancer-causing virus known as HPV, Januvia, a diabetes medicine, Rotateq, a vaccine for rotavirus, and Zostavax, a shingles vaccine. Back in 2003 and 2004, few observers gave these drugs any chance of achieving blockbuster sales status.

"Their pipeline was grossly undervalued," says Deutsche Bank analyst Barbara Ryan, who admits to being an early skeptic. "But they've executed handsomely and have been much more successful than we thought they would be." Now that all but Isentress have reached pharmacy shelves, analysts expect each of the new cadre of treatments to generate well over $1 billion annually at their sales peak.

Granted, Merck's new drugs were in the works for years before the company hit its morale-sapping low point in 2004. Even so, Merck should get credit for pulling off the final phases of research and subsequent product launches without a hitch. Investors have certainly rewarded Merck for its efforts. The company's shares have more than doubled to more than $53 from their post-Vioxx low of around $26 (which occurred in October of 2005).

One noteworthy culture shift at Merck has been a departure from the company's go-it-alone research strategy. Since 2004, Merck has entered into roughly 125 collaborative research deals, mostly with smaller drugmakers.

There's more to come, according to Robert Hazlett, an analyst with BMO Capital Markets. "We believe Merck is applying techniques that can provide it with a material advantage over its peers, creating the potential for sustained robust growth for the company," writes Hazlett in a recent note to investors. Indeed, Merck - with the help of investments in new processes, such as computerized efficacy screening - has reduced the average time it takes to usher a drug through the final stages of research by roughly 11 months. That improvement can pay enormous dividends. It gets medicines to patients sooner and adds nearly a year to the limited period in which Merck can sell its future medicines under patent protection.

Merck's Isentress was one of the drugs that moved through the labs at a faster than expected pace. Scientifically, it is fairly representative of the kinds of medicines Merck has favored recently. It is innovative in its mode of action. The medicine works by preventing the HIV virus from infusing its DNA into the DNA of a patient, making it a convenient last line of defense for doctors treating patients who have developed resistance to other therapies. Says Robin Issacs, a clinical researcher who worked on the Isentress project: "We're very excited because this drug is the first of its kind. We're starting on a whole new playing field." From the look of it, the entire company has too.