Merck Looks Cheap At 23x Forward Earnings. It Should.

Keytruda is the monoclonal antibody that inhibits PD-1, enabling the immune system to attack cancer cells. It has expanded from initial melanoma approval in 2014 to over 40 cancer indications today. Revenue grew from essentially zero at launch to approximately $31 billion in FY2025. The franchise alone represents roughly 48% of Merck's consolidated revenue and a disproportionately larger share of operating profit given high gross margins.

Merck has pursued multiple strategies to extend the Keytruda franchise beyond the 2028 patent expiry. Subcutaneous formulations (approved for launch by end of FY2026) could convert some of the franchise to next-generation patent protection. Combination therapies with novel agents could establish new clinical claims that protect a portion of demand. Both strategies have merit but neither preserves the full economic base.

The subcutaneous formulation at best preserves approximately 30-40% of the franchise revenue at post-conversion pricing. Combination therapies with new indications add a smaller percentage. Aggregate franchise retention past 2028 is most likely 35-50% of pre-expiry levels by FY2031. That leaves a $15-20 billion annualised revenue hole to fill.

Merck's non-Keytruda pipeline is concentrated around several programmes: Winrevair (pulmonary arterial hypertension), Welireg (renal cell carcinoma), Capvaxive (pneumococcal vaccine), and the recently acquired Prometheus Biosciences portfolio. Each could become a meaningful franchise but none approach Keytruda's scale. Winrevair at peak could be $3-4 billion annualised. Welireg peaks at $1-2 billion. Capvaxive might reach $1.5 billion. Prometheus products combined add $2-3 billion potential. Aggregate replacement potential from existing pipeline: $7-10 billion.

That is insufficient. The Keytruda revenue hole from LOE is $15-20 billion. The pipeline covers perhaps half the gap at best. The rest needs to come from acquisitions Merck has not yet announced.

This is the specific argument the bulls under-weight. Merck needs to execute approximately $25-40 billion of net acquisitions between now and 2028 to close the portfolio gap. That is a high bar. Historical pharma acquisitions at that scale have produced mixed returns; Pfizer's Seagen integration is ongoing, Bristol-Myers' Celgene was painful. Merck's M&A track record is respectable but not exceptional. The bulls are essentially betting on successful execution of a programme that has not yet been announced.

The Risk Desk modelled Merck's FY2030 earnings under three scenarios. Scenario one (optimistic): subcutaneous Keytruda preserves 45% of franchise, pipeline delivers $10 billion incremental, disciplined M&A adds $15 billion. FY2030 EPS approximately $10.50. Scenario two (base case): subcutaneous preserves 35%, pipeline delivers $7 billion, M&A adds $10 billion. FY2030 EPS approximately $8.00. Scenario three (pessimistic): subcutaneous preserves 25%, pipeline delivers $5 billion, M&A underperforms. FY2030 EPS approximately $6.00.

Current FY2025 EPS is approximately $9.60 after the cyclical recovery. In two of three scenarios, FY2030 EPS is below current FY2025 EPS. Even in the optimistic scenario, EPS growth over five years is essentially flat. That is not consistent with a 23x forward multiple. The sector average multiple for flat-growth pharma is 11-13x. At 12x the base case EPS, fair value is approximately $96 per share. That is 20% below current levels.

The scenario-weighted fair value across the three paths is approximately $95-110 per share. The midpoint is below the current $120 share price. That is the specific arithmetic supporting the bear thesis.

The most direct precedent is Pfizer's Lipitor LOE in 2011. Lipitor generated $13 billion of revenue at peak against Pfizer's $67 billion total revenue, or 19% of consolidated. Keytruda today is 48% of Merck's revenue. The concentration impact is much more severe. Pfizer's stock compressed by 22% over the 18 months before and after Lipitor LOE, then traded sideways for four years as the replacement portfolio was rebuilt. Merck's stock is likely to experience similar mechanics with larger magnitude given the concentration difference.

Bristol-Myers faced a similar pattern with Plavix LOE in 2012. Revenue base was smaller but concentration impact was proportional. Bristol-Myers stock compressed 25% over 24 months around LOE. The subsequent recovery required Opdivo, Yervoy, Eliquis, and the eventual Celgene acquisition to rebuild earnings power. That took eight years.

Across both precedents, the pattern is the same. Market begins pricing LOE risk 24-36 months ahead of expiry. Multiple compresses gradually through the window. Stock underperforms the sector by 15-25 percentage points. We are currently approximately 30 months from Keytruda LOE. The compression window has started, which is why Merck has underperformed the sector by roughly 18 percentage points over the past twelve months.

Merck's non-Keytruda businesses are profitable but smaller in scale than the franchise at risk. Animal Health revenue reached $5.9 billion in FY2025 with operating margin in the mid-20s. Vaccines (excluding Gardasil) added another $6.8 billion with variable margins. Gardasil itself is approximately $9 billion annualised and has faced its own pricing pressure in the China market that has reduced growth rates to single digits.

These segments combined generate approximately $22 billion of revenue with operating income of roughly $7 billion. They are meaningful businesses but cannot grow fast enough to offset the Keytruda decline. Animal Health has historically compounded at 6-8% annually; vaccines at 4-6%. Neither growth rate is sufficient to fill the gap on the required timeline.

The Risk Desk view is that these businesses provide a earnings floor around the $4-5 billion quarterly level post-LOE but do not accelerate through the LOE transition. They are stabilisers rather than growth engines. The valuation does not receive meaningful incremental credit from these segments in the forward earnings framework.

Merck has been a disciplined capital returner, running approximately $8 billion of buybacks and $7.5 billion of dividends annually. Combined $15.5 billion of capital return consumed approximately 125% of free cash flow in FY2025, partially funded from balance sheet cash. The pace is sustainable through FY2027 but cannot continue at current levels through the LOE transition.

Post-LOE, the Risk Desk models capital return compressing to $10-12 billion annually during the rebuild phase. That is a meaningful reduction. The dividend should hold, as Merck has historically prioritised dividend stability over buyback pace. But the buyback programme will slow. Slower buybacks reduce per-share EPS growth which pressures the multiple further.

The interaction between slower buybacks and lower absolute earnings compounds the multiple compression scenario. This is the specific combination of factors that creates the bear case's sharpest downside.

Four specific near-term events will determine whether the Risk Desk's bearish view compresses faster or slower than currently modelled. First, the Q2 2026 launch of subcutaneous Keytruda and the uptake rate in the first six months. An uptake rate above 40% in the first two quarters would suggest the franchise retention will be toward the higher end of our modelling. Below 25% would indicate franchise retention at the lower end.

Second, the FY2026 M&A announcements. If Merck completes $10-15 billion of acquisition activity by end of calendar 2026, the portfolio rebuild thesis gains credibility. If the company remains focused on smaller bolt-on deals, the gap-filling timeline extends.

Third, the biosimilar filing landscape. Multiple competitors have filed biosimilar Keytruda submissions. The specific FDA approval timing and labelling will determine how aggressively the biosimilars compete immediately post-LOE. Broad indication approvals for biosimilars would compress Keytruda pricing faster. Narrow approvals would preserve some of the franchise.

Fourth, the pipeline readouts for Winrevair, Welireg, and the early-stage oncology programmes. Clinical data that exceeds consensus for any of these would provide incremental earnings support. Data misses would narrow the replacement path further. All four of these events carry discrete date windows that will be informative.

The Lipitor precedent at Pfizer is instructive in specific numbers. Pfizer's stock price at Lipitor LOE in November 2011 was approximately $20. The stock did not return to $20 on a sustainable basis until mid-2013, and meaningful earnings recovery did not begin until 2014 with Ibrance and other franchise products. The period from peak Lipitor earnings to recovery was approximately three years with a 22% average underperformance to sector.

More relevant is the Humira precedent at AbbVie. Humira was 40% of AbbVie revenue at peak, similar concentration to current Merck Keytruda position. AbbVie experienced 25% revenue compression on Humira LOE (less than we are modelling for Keytruda given successful Skyrizi and Rinvoq launches). The AbbVie stock was roughly flat for three years post-LOE announcement and is still working through biosimilar pricing pressure.

The Humira case is the bull playbook: successful same-class replacement therapies (Skyrizi and Rinvoq) neutralised most of the Humira loss economically. Merck's equivalent would require the subcutaneous Keytruda or pipeline combination therapies to fully replicate the original franchise economics. That is a higher bar than Skyrizi/Rinvoq successfully attacked for AbbVie. The Risk Desk does not believe the probability of comparable success at Merck exceeds 30%.

For investors who currently hold Merck in a diversified portfolio, the Risk Desk's recommendation is to trim rather than hold at current levels. The multiple has compressed modestly over the past year but not enough to compensate for the visible LOE risk. Proceeds from trimming should be rotated toward pharma peers with cleaner post-LOE trajectories: Eli Lilly for GLP-1 growth, AbbVie for Skyrizi/Rinvoq momentum, or Vertex for cystic fibrosis franchise durability. Each of those names carries different risks but none carries the specific concentration exposure that Merck does.

For investors considering new positions, the Risk Desk would wait. The $120 entry price does not compensate for the forward earnings risk. A pullback to $100-105 on any negative LOE-adjacent data point would create a better entry. The multiple compression path is visible; patient investors can enter at materially better prices with higher probability over the next twelve to eighteen months.