The existing alliance between Merck (MRK) and Belgian biotech company Galapagos over metabolic diseases was recently expanded to develop new therapies for atherosclerosis, or hardening of arteries due to cholesterol build-up.

Following the deal, Galapagos will be eligible to receive potential milestone payments exceeding €400 million (approx $597 million). Additionally, the company will receive royalties on commercialization of the products.

Merck and Galapagos entered into a diabetes and obesity drug alliance in January this year. Galapagos was eligible to receive an upfront payment of €1.5 million (approx $2.23 million) and potential milestone payments totaling €170 million (approx $253 million).

Earlier, in October last year, Merck decided to terminate its late-stage obesity drug taranabant after determining that the drug was effective in high doses, which in turn triggered side effects.

Merck entered into another deal with Galapagos in April 2009, under which Galapagos will be using its Silence Select target discovery platform to identify inflammatory disease targets. Galapagos will receive an upfront fee of €2.5 million (approx $3.7 million) in addition to potential milestone payments exceeding €192 million (approx $286 million) and royalties on successful commercialization of the products.

We believe Merck is entering into several partnership arrangements to boost its top line, which is suffering from generic competition for many of its drugs. The company is also contending with softening sales of key drugs, such as Singulair and Gardasil, which have hampered earnings in the last few quarters. It has also entered into a merger with Schering-Plough (SGP) to address its slowing sales and EPS growth.

The Schering merger is clearly an attempt by Merck to overcome significant patent challenges over the next four years while Schering has relatively little exposure to patent expirations through 2013. Given the minimal product overlap, we would expect the combination to provide significant synergistic opportunities with combining sales, marketing, research and other back-office functions. The deal should also help to geographically diversify revenue sources as Schering currently has about 70% of revenues coming from overseas, versus only 44% for Merck. We have a Neutral recommendation on the stock.

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