Merck reaches outside its lab doors

(Fortune) -- Merck's $702 million deal with Swiss biotech Addex, announced today, to co-develop a schizophrenia drug may not be a huge deal in the multibillion-dollar world of Big Pharma. But it offers further evidence that the U.S. drug giant is securing its future by essentially outsourcing its research and development to smaller, nimbler firms.

In the terms of the deal, Merck (MRK, Fortune 500) will license an investigative schizophrenia compound from Addex. Merck agreed to pay Addex an initial $22 million, and will later dole out milestone payments and royalties of $680 million if and when the Addex's drug progresses through various stages of clinical testing and FDA approval.

It's a dramatic departure from Merck's former way of doing business. For years, the company fell victim to its own success as scientists relied too heavily on potential drugs developed in-house and looked down on the practice of "in-licensing" promising medicines from outside companies.

As more of Merck's peers increased their licensing deals - and as Merck's own pipeline began to dry up earlier this decade - the company made a concerted effort to court joint ventures and other deals. In 1999, for instance, Merck entered into just 10 licensing deals with smaller pharma companies and biotech firms. By contrast, in 2006, the company orchestrated 53 such agreements, including three acquisitions of small pharma firms. Merck estimates that it signed more than 50 deals in 2007, including one relatively small acquisition. Merck's 2007 dealmaking added three new compounds to its late-stage pipeline.

That Merck has begun to look outside its walls for prospective groundbreaking medicines is a critical part of the company's recent recovery. Since the beginning of 2006, Merck's shares have risen 75%, propelled the introduction of 8 new medicines and by an announced settlement of the company's Vioxx lawsuits.

Moreover, the approach Merck and Addex will use may change the very nature of treating schizophrenia. The compound Merck will co-develop with Addex, known in the labs as "ADX63365", is said to relieve patients of psychotic symptoms such as internal voices, paranoia, and anxiety. What sets Addex's medicine apart from other currently-marketed schizophrenia medicines, researchers believe, is that their compound is able to reverse cognitive impairments that prevent some schizophrenics from learning new skills or keeping a job.

If those beliefs are proven in the clinic, that's certainly enough to make ADX63365 a success among the 2.2 million American adults who suffer from schizophrenia. And it may have broader uses. The compound acts on a central nervous receptor that researchers believe is an important target for treating not just schizophrenia, but other cognitive conditions such as Alzheimer's. Says Merck spokesman, Ian McConnell: "This deal showcases our teaming up with the best and brightest in the field."

McConnell jokingly makes reference to Merck's formerly haughty attitude toward in-licensing. "Merck now realizes that 99.9% of great research is done outside of Merck Research Labs," he quips. That's exactly that kind of self-examination that has helped to turn Merck around.