merck kgaa - credit suisse

DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

20 May 2016Europe/GermanyEquity Research

Specialty Pharmaceuticals

Merck KGaA (MRCG.DE)

COMPANY UPDATE Rating OUTPERFORMPrice (18 May 16, €) 82.59Target price (€) 104.00Market Cap (€ m) 41,248.9Enterprise value (€ m) 52,172.3*Stock ratings are relative to the coverage universe in each analyst's or each team's respective sector.¹Target price is for 12 months.

Research AnalystsEuropean Pharma Team

44 207 888 [email protected]

Rebekah Harper44 20 7888 2124

[email protected]

Trung Huynh44 20 7888 2102

[email protected]

Jo Walton44 20 7888 0304

[email protected]

Matthew Weston PhD44 20 7888 3690

[email protected]

Specialty Sales - Philip Gestrin44 20 7888 1000

[email protected]

1Q16 Second Opinion■ Strong 1Q and bullish 2016 earnings guidance. Merck reported 1Q

results 7-8% ahead of expectations driven by better Healthcare margins and lower interest expense. Life Science and Performance Materials were in line despite a modest destocking of the LCD supply chain. First time quantitative earnings guidance was ahead of CS expectations at the midpoint. We lower sales by c.3% solely on FX (Venezuela pressure in 1H16). We raise FY16 EPS by 7% and make negligible changes to mid-term EPS forecasts.

■ Life Science organic growth, Sigma synergies and Healthcare optionality drive mid-term potential. Following the Sigma acquisition, Merck is one of the leading life science tools players benefiting from 4-5% organic market growth. On top of this, earnings should grow significantly faster than revenue as the Sigma synergies crystallise. From this foundation Healthcare offers significant pipeline optionality. 2016 catalysts for avelumab, atacicept, BTK platform and PD-L1+TGFb bispecific plus Life Science profitability at the top of the guidance range could add over 8% to Equity NPV. We acknowledge that the company's historic R&D track record is poor, but changes to Healthcare operational and R&D management in recent years open the way for more industry-standard probabilities of success, in our view. Given this potential, valuation relative to peers remains unjustifiably low.

■ Catalysts: 2Q16: ASCO data & avelumab filing in MCC. 2H: atacicept P2 data, PD-L1+TGFb bispecific proof of concept and updates on BTK in lupus. 2016 is also a key year for delivery of Sigma synergies.

■ Valuation: Merck trades on 15.2x 2016 PE, a 15% discount to EU specialty peers and a 32% discount to consensus Global Life Science peers. Using CS PharmaValues, Merck trades on 0.92x EV/NPV, a 20% discount to peers.

Share price performance

M RCG.D E D EUT SCH E BO RSE D A X IN D EX

Ju l - 1 4 Jan - 1 5 Ju l - 1 5 Jan - 1 65 0

7 5

1 0 0

1 2 5

The price relative chart measures performance against the DEUTSCHE BORSE DAX INDEX which closed at 9943.2 on 18/05/16On 18/05/16 the spot exchange rate was €1/Eu 1.- Eu.89/US$1

Performance 1M 3M 12MAbsolute (%) 4.2 8.6 -17.3Relative (%) 9.3 4.0 -0.2

Financial and valuation metricsYear 12/15A 12/16E 12/17E 12/18ERevenue (€ m) 12,844.7 15,162.6 15,210.5 15,539.8EBITDA (€ m) 3,599.8 4,178.8 4,334.1 4,714.3Adjusted net income (€ m) 2,087.20 2,524.15 2,630.07 2,940.95CS EPS (adj.) (€) 4.80 5.81 6.05 6.76Prev. EPS (€) - 5.43 6.00 -Core comp EPS 4.80 5.81 6.05 6.76P/E (adj.) (x) 17.2 14.2 13.7 12.2P/E rel. to local mkt (%) 142.0 115.9 122.8 116.8EV/EBITDA (x) 15.0 12.5 11.6 10.3

Dividend (12/16E, €) 1.10 Net debt/equity (12/16E,%) 78.6Dividend yield (12/16E,%) 1.3 Net debt (12/16E, € m) 10,923.4BV/share (12/16E, €) 31.9 IC (12/16E, € m) 24,819.0Free float (%) 26.0 EV/IC (12/16E, (x) 2.1Source: Company data, Thomson Reuters, Credit Suisse estimates

20 May 2016

Merck KGaA (MRCG.DE) 2

Merck KGaA (MRCG.DE)Price (18 May 2016): €82.59; Rating: OUTPERFORM; Target Price: €104; Analyst: Rebekah HarperIncome statement (€ m) 12/15A 12/16E 12/17E 12/18ERevenue 12,845 15,163 15,210 15,540EBITDA 3,600 4,179 4,334 4,714Depr. & amort. (1,409) (1,724) (1,729) (1,743)EBIT 3,125 3,635 3,785 4,152Net interest exp. (357) (280) (290) (270)Associates 0 0 0 0Other adj. 0 0 0 0PBT 2,768 3,355 3,495 3,882Income taxes (368) (706) (668) (765)Profit after tax 2,400 2,649 2,827 3,117Minorities (9) (9) (9) (9)Preferred dividends -0 -0 -0 -0Associates & other (304) (116) (188) (167)Net profit 2,087 2,524 2,630 2,941Other NPAT adjustments (978) (985) (1,154) (1,105)Reported net income 1,109 1,539 1,476 1,836Cash flow (€ m) 12/15A 12/16E 12/17E 12/18EEBIT 3,125 3,635 3,785 4,152Net interest 0 0 0 0Cash taxes paid 0 0 0 0Change in working capital (8) (120) (60) (70)Other cash and non-cash items (1,029) (470) (657) (645)Cash flow from operations 2,088 3,045 3,068 3,437CAPEX (694) (858) (861) (877)Free cash flow adj. (180) (100) (100) (100)Free cashflow to the firm 1,394 2,187 2,208 2,560Acquisitions (13,482) 0 0 0Divestments 36 0 0 0Other investment/(outflows) (0) 0 0 0Cash flow from investments (14,140) (858) (861) (877)Net share issue/(repurchase) 0 0 0 0Dividends paid (564) (457) (478) (522)Issuance (retirement) of debt - - - -Others 521 (0) 0 0Cashflow from financing (564) (457) (478) (522)Effect of exchange rates 0 0 0 0Changes in net cash/debt (12,095) 1,730 1,729 2,038

Net debt at start 559 12,654 10,923 9,194Change in net debt 12,095 (1,730) (1,729) (2,038)Net debt at end 12,654 10,923 9,194 7,156Balance sheet (€ m) 12/15A 12/16E 12/17E 12/18EAssetsCash & equivalents 832 2,562 4,292 6,330Accounts receivable 3,235 3,621 3,814 4,039Inventory 2,620 2,933 3,089 3,272Other current assets 664 665 688 715Total current assets 7,350 9,781 11,883 14,356Total fixed assets 4,009 4,235 4,457 4,683Intangible assets and goodwill 25,339 24,247 23,156 22,064Investment securities 0 0 0 0Other assets 1,309 1,309 1,309 1,309Total assets 38,007 39,572 40,805 42,412LiabilitiesAccounts payables 1,921 2,151 2,265 2,399Short term debt 4,097 4,097 4,097 4,097Other short term liabilities 3,365 3,767 3,968 4,203Total current liabilities 9,383 10,014 10,330 10,699Long term debt 9,616 9,616 9,616 9,616Other liabilities 6,153 6,045 5,959 5,877Total liabilities 25,152 25,676 25,905 26,192Shareholders' equity 12,788 13,828 14,832 16,153Minority interests 68 68 68 68Total equity and liabilities 38,007 39,572 40,805 42,412Net debt 12,654 10,923 9,194 7,156

Per share 12/15A 12/16E 12/17E 12/18ENo. of shares (wtd avg.) (mn)

435 435 435 435CS EPS (adj.) (€) 4.80 5.81 6.05 6.76Prev. EPS (€) - 5.43 6.00 -Dividend (€) 1.05 1.10 1.20 1.30Dividend yield (%) 1.27 1.33 1.45 1.57Dividend payout (%) 21.87 18.95 19.84 19.22Free cash flow per share (€)

2.79 4.80 4.85 5.66Key ratios and valuation 12/15A 12/16E 12/17E 12/18EGrowth (%)Sales growth (%) 12.9 18.0 0.3 2.2EBIT growth (%) 9.7 16.3 4.1 9.7Net income growth (%) 4.3 20.9 4.2 11.8EPS growth (%) 4.3 20.9 4.2 11.8Margins (%)EBITDA margin (%) 28.0 27.6 28.5 30.3EBIT margin (%) 24.3 24.0 24.9 26.7Pretax profit margin (%) 21.6 22.1 23.0 25.0Net income margin (%) 16.2 16.6 17.3 18.9Valuation 12/15A 12/16E 12/17E 12/18EEV/Sales (x) 4.2 3.4 3.3 3.1EV/EBITDA (x) 15.0 12.5 11.6 10.3EV/EBIT (x) 17.2 14.4 13.3 11.7P/E (x) 17.2 14.2 13.7 12.2Price to book (x) 2.8 2.6 2.4 2.2Asset turnover 0.3 0.4 0.4 0.4ROE analysis (%) 12/15A 12/16E 12/17E 12/18EReturn on equity stated (%)

9.0 11.5 10.3 11.8ROIC (%) 9.3 11.1 11.9 13.5Interest burden (x) 0.9 0.9 0.9 0.9Tax rate (%) 24.8 31.3 31.0 29.3Financial leverage 1.1 1.0 0.9 0.8Credit ratios (%) 12/15A 12/16E 12/17E 12/18ENet debt/equity (%) 98.4 78.6 61.7 44.1Net debt to EBITDA (x) 3.5 2.6 2.1 1.5Interest coverage ratio (x) 8.8 13.0 13.1 15.4

Share price performance

MRCG.DE DEUTSCHE BORSE DAX INDEX

Jul- 14 Jan- 15 Jul- 15 Jan- 1650

75

100

125

The price relative chart measures performance against the DEUTSCHE BORSE DAX INDEX which closed at 9943.2 on 18/05/16On 18/05/16 the spot exchange rate was €1/Eu 1.- Eu.89/US$1

Source: FTI, Company data, Thomson Reuters, Credit Suisse Securities (EUROPE) LTD. Estimates

20 May 2016


Pipeline potential offers 8% NPV upsideFollowing the Sigma acquisition, Merck is one of the leading life science tools players benefiting from 4-5% organic market growth. On top of this, earnings should grow significantly faster than revenue as the Sigma synergies crystallise.

From this foundation Healthcare offers significant pipeline optionality, in our view. 2016 catalysts for avelumab (Merkel Cell, ovarian and other indications), atacicept (lupus), proof of concept and potential partnering of the BTK platform (immunology & oncology) and proof of concept for the PD-L1+TGFb bispecific could add significantly to our PharmaValues Equity NPV.

Figure 1 sets out a Blue Sky PharmaValues NPV sensitivity on potential catalysts over the next 12 months at Merck KGaA. We see the potential for an 8% increase in PharmaValues NPV as avelumab seeks regulatory approval in Merkel Cell Carcinoma (MCC) and various pipeline assets show proof of concept. Based on a target EV/NPV multiple of 1.04 (in line with European specialty pharma peer average excl. premium outliers Recordati, Meda & Orion), this would imply a Blue Sky equity valuation for Merck KGaA of c.EUR 104, in line with our target price.

We acknowledge that the company's historic R&D track record is poor, but changes to Healthcare operational and R&D management in recent years open the way for more industry-standard probabilities of success, in our view. Given this potential, valuation relative to peers remains unjustifiably low.

Figure 1: PharmaValues NPV upside on potential catalysts over next 12 months

91.38

98.68

104.02

60

65

70

75

80

85

90

95

100

105

BASE CASEEquity NPV

Life Sciencetop of

guidancerange

avelumabMerkel 75%

to 100%prob

avelumabother 25% to

60% prob

tepotinib25% to 60%

prob

atacicept20% to 60%

prob

BTK $250mupfront &5% to 20%

prob

PD-L1 + TGFbTRAP 10% to

25% prob

BLUE SKYEquity NPV

ImpliedBLUE SKY

share priceEV/NPV =

1.04

Equi

ty N

PV, E

UR

per s

hare

Source: Company data, Credit Suisse estimates

20 May 2016


Changes to our forecast■ Following 1Q results we reduce sales by an average 3% 2016-2020. This is driven

largely by a revised FX impact on sales due to the impact of devaluation in Venezuela.

■ For FY16 we raise our underlying Core EPS estimates by 7%, driven by two changes. Firstly higher profitability in Healthcare following the higher gross margin seen in 1Q and management's comment that this is sustainable. Secondly, we lower our assumptions for financial charges following the experience in 1Q and strong cashflow generation, including cash in from the sale of Kuvan.

Figure 2: Changes to our forecastsOLD 2015A 2016E 2017E 2018E 2019E 2020E 15-20 CAGR

Group Sales 12,845 15,581 15,758 16,116 16,499 16,939 6%

EPS CreditSuisse BASIS (pre intang/pre CS excep)4.80 5.43 6.00 6.76 7.40 7.90 10%

EPS underlying 4.80 5.43 6.00 6.76 7.40 7.90 10%

EPS reported 2.55 2.63 3.34 4.20 4.89 5.39 16%

NEW 2015A 2016E 2017E 2018E 2019E 2020E 15-20 CAGR

Group Sales 12,845 15,163 15,210 15,540 15,913 16,345 5%

EPS CreditSuisse BASIS (pre intang/pre CS excep)4.80 5.81 6.05 6.76 7.38 7.90 10%

EPS underlying 4.80 5.81 6.05 6.76 7.38 7.90 10%

EPS reported 2.55 3.54 3.40 4.22 4.89 5.40 16%

% CHANGE 2015A 2016E 2017E 2018E 2019E 2020E

Group Sales 0.0% -2.7% -3.5% -3.6% -3.6% -3.5%

EPS CreditSuisse BASIS (pre intang/pre CS excep)-0.1% 7.0% 0.8% 0.1% -0.2% 0.0%

EPS underlying -0.1% 7.0% 0.8% 0.1% -0.2% 0.0%

EPS reported 0.0% 34.4% 1.8% 0.5% 0.0% 0.2%


CS vs company guidanceFigure 3: Credit Suisse estimates versus company guidance for FY16

2016 guidance 2016EMar-15 May-15 CS estimates

Healthcare Erbitux - -1%Rebif "continued organic decline" -14%

Revenue growth "slight organic growth" "slight organic growth" 3%EBITDA pre one-time "high single to mid-teens decline" €1.8bn to 1.9bn 1.86

Performance Materials Revenue "slight organic growth" "organic stable" 3%EBITDA pre one-time "slight increase, at least at prior year" €1.1bn to 1.15bn 1.11

Life Science Revenue growth "moderate organic growth" "mid single digit lc growth" 5%EBITDA pre one-time "high double digit increase" €1.62bn to 1.67bn 1.60

Corporate/other -€370 to 400m -€370 to 400m -385

Group Group Sales "Growth in low double digits inc Sigma" €14.8bn to 15bn 15.2- ex Sigma "slight organic growth" 5.0%Interest result -€270 to 300m -230Intangible amort from Sigma -€250 to 300m -273Tax rate "23% to 25%" 24.5%EBITDA pre one-time "increase in low double digits" €4.1bn to 4.3bn 4.18Core EPS €5.65 to 6.00 5.81


20 May 2016


Comparative valuationFigure 4: EU specialty pharma comparative valuation

15-20 15-20 Equity

EU Specialty price 2015A 2016E 2017E 2018E 2019E 2020EL.C Sales growth*

L.C EPS growth

Div Yield 2016E EV/NPV

NPV/ share

NPV/ share

Almirall € 13.3 48.7 32.2 27.6 21.7 16.9 12.2 7.6% 31.8% 1.7% 1.34 9.4 12.0Ipsen € 54.1 19.5 19.7 17.6 14.4 13.1 11.6 6.5% 10.9% 1.7% 0.94 57.3 56.8Lundbeck DK 240 nr 34.3 25.6 20.1 15.3 14.8 1.8% 56.6% 0.3% 0.87 272 268Meda (pre-amortisation) SK 149 16.5 11.6 11.1 10.2 9.7 11.6 0.3% 7.3% 2.4% 1.36 157 95Merck KGaA € 83 17.2 15.2 13.8 12.2 11.2 10.5 5.7% 10.5% 1.3% 0.92 127 92Orion € 30.8 21.5 21.5 21.4 21.0 19.8 18.5 2.7% 3.1% 3.9% 1.47 20.5 20.9Recordati € 24.4 23.1 20.6 21.0 20.6 20.2 20.1 2.6% 2.9% 2.4% 1.49 15.0 15.1Shire Pharmaceuticals p 4098 15.3 14.2 12.5 10.4 9.3 8.7 9.2% 12.1% 0.5% 1.26 3599 3072UCB € 66.7 37.0 23.1 19.6 15.8 13.3 11.7 5.5% 25.9% 1.7% 0.85 93.1 85.9EU Specialty average (ex UCB/Lundbeck/ALM)19.7 17.8 16.7 15.3 14.2 13.8 4.5% 8.0% 1.7% 1.17Merck KGaA premium/(discount) -13% -15% -18% -20% -22% -24% -21%

P/E


1Q16 results commentaryINTRODUCTORY COMMENTS

Healthcare –good organic growth and first avelumab P3 combo trial start Life Science –strong performance continues; Sigma integration on track Performance Materials – anticipated first supply chain destocking but still

healthy profitability Focus on deleveraging on track. Net financial debt decreased by c.€600m

1Q16 Financials Underlying EBITDA: Life Science and Healthcare drive increase Currency: -6.8% negative currency impacted from change in currency

accounting in Venezuela from mid-15. Seeing big effects YoY from this effect Life Science: strong organic growth driven by Sigma and positive product mix Performance Materials: slightly lower due to product mix Corporate EBITDA pre: contains hedging and investments in corporate

initiatives Working capital: up +8.0% reflecting growth of company.

Healthcare Solid quarter. US contributed sig. to growth from fertility (shortage from

competitors) and favourable development of Rebif M&S reflect end of commission expenses for Rebif (US) partially offset by

reinvestments in sales force & launch preparations R&D increases expected as avelumab Phase III trials progress Rebif performance driven by main brand performance in US and price

increase offsetting volume decline. Europe remains challenging. Expect sales to decline organically in 2016

Avelumab. Initiated two combo trials in ovarian and triple combo in solid tumours in 1Q16. Expect to file end 2Q16/start 3Q16

Life-science Strong quarter (9% YoY) driving by Process Solutions Applied Solution showed moderate growth

20 May 2016


Performance materials Decline in more established liquid cystals (LC) and destocking previously

flagged New LC modes (eg. UBFFS) and OLED showing good growth Pigments 4% growth Destocking will go into 2Q but fall off thereafter

Newsflow Avelumab: Data readout Phase II MCC (1H16) Cladribine: Expected EMA filing (1H16) Sprifermin: Data readout Phase II (2H16) Atacicept: Data readout Phase II (2H16) M7824 (PD-L1+TGFb TRAP bispecific): Dose escalation outcome (2H16) Tepotinib: Data readout Phase II (1H17) R&D update call- June 20, 2016

QuestionQ. What is the relative efficacy in Merkel Cell vs. Keytruda (which was in first-line)?A. Very difficult to compare the data sets. Pembro was in 1st line in a subset of 26 patients, while avelumab is in 2nd-line and had a similar response to SoC. More information on the plan of avelumab in 1st-line expected on R&D call at the end of June.

Q. Do you think Keytruda is fileable in Merkel Cell?A. Will not comment but it is in a small study conducted by investigators and not against an active comparator. Merck's plans assume a comparator arm will be required for first-line filing.

Q. Is there any additional efficacy from M7824 (PDL1 and TGF beta bispecific)?A. The study was started before Pfizer partnership announcement and is on track. Gearing up with Pfizer to execute future clinical trial plans.

Q. Where are LCD inventory levels? Can you quantify?A. At the end of 2015, inventory levels were around 4-weeks, which is above the mid-term average. Destocking is taking place and expected to last till mid-year with growth thereafter. Supply and demand is expected to normalise as prices decrease.

Q. When will LC windows and smart antenna contribute to top line?A. This is a mid-term plan which will take time to commercialise. Could start contributing around 2020, 2017/18 unlikely.

Q. 1Q Life science growth was 9% but guidance is 5%, do you expect headwinds?A. Life-science is still benefiting from distribution agreement with Roche, which saw good sales in 2H15. Can't expect 9% to be sustained and should grow in line with the market, which is mid-single digit.

Q. BTK inhibitor update? Is competitive environment getting tougher.A. P1b trial results in systemic lupus in 2H16. Preparing for P2 in RA and SLE. Given high selectively Merck is focusing on immunology. Will partner at the right time and likely to pursue oncology in future with a partner.

Q. Are the Gonal F competitor supply issues resolved? What will happen when the competitor comes back?A. Does not know when the competitor will come back. Strong demand is also from good operational performance.

20 May 2016


Q. GM in Pharma was around 81%, is this a reasonable level going forward?A. Current gross margin level is sustainable. Effect of Rebif is declining but benefiting from price increases. Overall GM can be kept stable

Q. Iphone 7 will be OLED and 3D NAND technology. If Apple does go to OLED, what does this mean for PM?A. Vast majority of Merck's EBITDA-pre is related to TV. Tablets and iphones are minor. Challenge is to get the OLED business from Apple but overall impact not that big.

Q. What is the situation in the EU with regard to Fertility biosimilars?A. Now there is a second biosimilar in Germany, Spain and UK. Expecting future launches in France and Italy. Not seen much vol. impacts from first biosimilar. Some countries are affected by reference pricing but seeing high customer loyalty. Merck has significant access to fertility clinics. These new Biosimilars are aggressive in pricing which will push the price down but Merck will aggressively defend the volume. Net price depends on the country. List price of biosimilars is 20-25% decrease, there may be additional rebates offered on top of this.

Q. M2736 P2 data in MS?A. Small study. Data sometime in 2016. Focused on cladribine.

Q. When would we see the acceleration of OLED?A. Not many of big TV producers have made a bet on OLED but will see inflection when these come on board. Has gained a 20% market share in OLED space.

Q. Avelumab toxicity in Merkel Cell grade 3 and 4 events were low?A. Well tolerated, similar to other studies. Safety profile is good in these heavily pre-treated.

Q. What was the Rebif volume decline in the US?A. Mid-single digit

Q. How much of the -6.8% FX impact was from Venezuela?A. Was in mid to high double digit €m amount.

Q. Ramp up in R&D spend? A. Will see increase in R&D during 2016. Range of €250-300m which will be a slight and gradual increase QoQ.

Q. If P2 is positive would you commercialise sprifermin?A. Currently partnered out for P2. After seeing data in 2H16, Merck will look at options.

Q. Will you reallocate any spend from biosimilars to more innovative areas?A. Biosimilar investment on track for the year. Will move to 2017/18 prioritising portfolio so will have more clarity on innovative products and BS.

Q. OLED- when is the printing technology going commercial?A. Still in test and trial phase. Too early to speculate when it will be commercialised and topline impact.

Q. Operating cash flow expectation for the year?A. The 1Q €300m Operating cash flow is a good indication for the year. No major special items in this number.

20 May 2016


Figure 5: 1Q16 results summary

EURm 1Q15A 1Q16E Consensus*1Q16E 1Q16A CS

FY15ACS

FY16EConsensus*

FY16ECS

FY17EConsensus*

FY17E

EUR/U$ 1.14 1.10 1.10 1.10 1.09 1.11

HEALTHCAREErbitux ex-US 205 205 211 207 899 905 893 888 890Rebif 430 386 410 422 1,798 1,630 1,636 1,444 1,473Saizen/Serostim 91 98 89 387 416 392Gonal F 164 167 187 685 722 701Glucophage/XR 112 122 94 437 409 479Concor 121 133 107 463 438 453Euthyrox/thyroids 78 82 78 352 337 335Consumer Health 217 245 215 833 821 857Commission income 22 30 42 103 198 110

Total Healthcare sales 1,686 1,707 1,675 1,646 6,934 6,741 6,870 6,550 6,870

COGS reported -372 -401 -311 -1,442 -1,382 -1,441

SG&A reported -726 -678 -684 -3,061 -2,816 -2,714

R&D - reported -348 -384 -378 -1,310 -1,584 -1,507

Healthcare EBITDA pre-one time 461 492 474 508 1,972 1,857 1,775 1,781 1,735

Healthcare EBITDA margin 27.3% 28.8% 28.3% 30.9% 28.4% 27.6% 25.8% 27.2% 25.3%

PERFORMANCE MATERIALS

Total Performance Materials sales 617 644 620 622 2,556 2,624 2,579 2,738 2,628

- of which LCD sales 341 341 320 1,423 1,395 1,423

Performance Materials EBITDA pre-one time 277 265 273 274 1,131 1,106 1,134 1,148 1,154

Performance Materials EBITDA margin 44.8% 41.2% 43.9% 43.9% 44.2% 42.2% 44.0% 41.9% 43.9%

MERCK-MILLIPORE

Total Merck-Millipore sales 738 1,433 1,407 1,397 3,355 5,797 5,791 5,922 6,053

Merck-Millipore EBITDA pre-one time 184 387 388 393 856 1,600 1,633 1,729 1,845

Merck-Millipore EBITDA margin 24.9% 27.0% 27.6% 28.1% 25.5% 27.6% 28.2% 29.2% 30.5%

GROUP P&L

Corporate expense -69 -96 -91 -91 -360 -385 -367 -325 -334

Group revenue 3,041 3,784 3,704 3,665 12,845 15,163 15,240 15,210 15,551

Operating profit EBITDA pre-one time 853 1,048 1,043 1,084 3,600 4,179 4,175 4,334 4,401

EBITDA margin underlying 28.0% 27.7% 28.2% 29.6% 28.0% 27.6% 27.4% 28.5% 28.3%

Net financial income -101 -88 -68 -357 -280 -290

Net income - CORE 488 625 669 2,087 2,524 2,630

No. of shares 435 435 435 435 435 435

EPS CORE 1.12 1.44 1.42 1.54 4.80 5.81 5.67 6.05 6.09

Dividend per share 1.00 1.05 1.05 1.05 1.10 1.20

* Company VARA consensus as at 4 May 2016


20 May 2016


Merck KGaA catalystsFigure 6: Merck KGaA catalysts

1Q16 2Q16 3Q16 4Q16

HIGH

Pric

e se

nsiti

vity

LOW

Realisation of synergies from the SIAL acquisition

avelumab(Solid Tumors)

P1 data

atacicept(lupus)P2 data

avelumab(Merkel Cell Carcinoma)

Filing

cladribine(MS)

EU filing

avelumab(Merkel Cell Carcinoma)

accelerated US approval?

M7824 (PD-L1 + TGFb TRAP)

(Solid tumours)dose escalation outcome

BTK programme(haem cancer and immunology)

partnering potential & P1 data in lupus in 2H

Impact of Dow/DuPont merger on AZ Electronicspotential for bigger competitor with lower unit costs

✓Liquid CrystalsUpdate on inventory

patterns

✓avelumab(Merkel Cell Carcinoma)

data


20 May 2016


Summary P&LFigure 7: Summary P&L

P&L EURm 2013a 2014a 2015a 2016e 2017e 2018e 2019e 2020e CAGR 15-20eErbitux ex-US 882 904 899 905 888 880 871 861 -0.9%Rebif 1,865 1,840 1,798 1,630 1,444 1,322 1,230 1,146 -8.6%Campral 40 30 30 25 23 22 21 20 -7.8%Saizen 235 237 261 278 264 253 244 235 -2.1%Gonal F 586 628 685 722 701 692 688 689 0.1%Glucophage/XR 394 378 437 409 479 500 525 552 4.8%Concor 402 428 463 438 453 468 482 497 1.4%Thyroids (incl. Euthryox) 275 330 352 337 335 340 347 354 0.1%Pipeline (prob adj) 11 25 71 166Other 1,276 1,847 2,009 1,998 1,964 2,036 2,157 2,315 2.9%

Healthcare 5,954 6,620 6,934 6,741 6,550 6,514 6,565 6,668 -0.8%Consumer 742 - - - - - - -Performance Materials 1,642 2,060 2,556 2,624 2,738 2,849 2,928 3,002 3.3% - of which LCD 1,274 1,265 1,423 1,395 1,423 1,451 1,451 1,451 0.4%Life Science 2,628 2,683 3,355 5,797 5,922 6,176 6,420 6,675 14.7% - of which Sigma Aldrich 279 2,605 2,637 2,769 2,893 3,024Discontinued

Group Sales 10,700 11,363 12,845 15,163 15,210 15,540 15,913 16,345 4.9%Group Revenue 11,095 11,377 12,845 15,163 15,210 15,540 15,913 16,345 4.9%

Healthcare 1,855 1,918 1,972 1,857 1,781 1,973 2,156 2,254 2.7%Consumer 173 - - - - - - -Performance Materials 780 895 1,131 1,106 1,148 1,169 1,190 1,218 1.5%Life Science 643 659 856 1,600 1,729 1,902 2,022 2,136 20.1%DiscontinuedCorporate/other -197 -171 -360 -385 -325 -330 -335 -335

Group EBITDA pre-one time 3,253 3,300 3,600 4,179 4,334 4,714 5,034 5,273 7.9%

Healthcare 31.1% 29.0% 28.4% 27.6% 27.2% 30.3% 32.8% 33.8%Consumer 23.2% - - - - - - -Performance Materials 47.5% 43.4% 44.2% 42.2% 41.9% 41.0% 40.6% 40.6%Life Science 24.5% 24.6% 25.5% 27.6% 29.2% 30.8% 31.5% 32.0%Discontinued - - - - - - - -Corporate/other - - - - - - - -

Group EBITDA margin (underlying) 30.4% 29.0% 28.0% 27.6% 28.5% 30.3% 31.6% 32.3% -

Healthcare 1,643 1,721 1,754 1,682 1,611 1,804 1,986 2,081Consumer 0 - - - - - - -Performance Materials 678 764 1,020 991 1,028 1,044 1,061 1,086Life Science 532 548 732 1,368 1,492 1,655 1,766 1,869DiscontinuedCorporate/other -47 -185 -381 -406 -346 -351 -356 -356

Group EBIT (underlying) 2,806 2,848 3,125 3,635 3,785 4,152 4,456 4,680 -

Group operating profit (reported) 1,612 1,742 1,843 2,534 2,444 2,880 3,215 3,438 13.3%Operating margin reported 15.1% 15.3% 14.3% 16.7% 16.1% 18.5% 20.2% 21.0%

Net financial income -222 -205 -357 -280 -290 -270 -220 -150

PTP CS defined underlying 2,584 2,643 2,768 3,355 3,495 3,882 4,236 4,530 10.4%Pre-tax profit reported 1,389 1,537 1,487 2,254 2,154 2,610 2,995 3,288 17.2%

Tax underlying -659 -634 -672 -822 -856 -932 -1,017 -1,087 10.1%Tax rate (underlying) 25.5% 24.0% 24.3% 24.5% 24.5% 24.0% 24.0% 24.0%Tax -180 -392 -368 -706 -668 -765 -859 -929 20.3%Tax rate (reported) 12.9% 25.5% 24.8% 31.3% 31.0% 29.3% 28.7% 28.3%

Post-tax discontinued operations 0 0 0 0 0 0 0 0Minorities -7 -8 -9 -9 -9 -9 -9 -9 -0.7%Net income (CS basis) 1,918 2,002 2,087 2,524 2,630 2,941 3,210 3,434 10.5%Net income (reported) 1,203 1,137 1,109 1,539 1,476 1,836 2,127 2,350 16.2%

EUR/U$ 1.33 1.34 1.10 1.09 1.11 1.12 1.12 1.12

Per Share Data (EUR) 2013a 2014a 2015a 2016e 2017e 2018e 2019e 2020e CAGR 15-20eFully diluted number of shares (m) 435 435 435 435 435 435 435 435 0.0%

Credit Suisse EPS 4.41 4.60 4.80 5.81 6.05 6.76 7.38 7.90 10.5%EPS underlying (pre one time) 4.41 4.60 4.80 5.81 6.05 6.76 7.38 7.90 10.5%EPS (reported) 2.77 2.61 2.55 3.54 3.40 4.22 4.89 5.40 16.2%

DPS (EUR) 1.90 1.00 1.05 1.10 1.20 1.30 1.40 1.50 7.4%FCF per share EUR (CS definition) 3.94 4.75 3.21 5.03 5.08 5.89 6.49 7.00 16.9%


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Companies Mentioned (Price as of 18-May-2016)Almirall (ALM.MC, €13.31)Ipsen (IPN.PA, €54.14)Lonza (LONN.S, SFr168.4)Lundbeck (LUN.CO, Dkr239.8)Meda (MEDAa.ST, Skr149.4)Merck KGaA (MRCG.DE, €82.59, OUTPERFORM, TP €104.0)Orion (ORNBV.HE, €30.79)Recordati (RECI.MI, €24.4)Shire Pharmaceuticals (SHP.L, 4098.0p)UCB (UCB.BR, €66.67)

Disclosure AppendixImportant Global Disclosures Rebekah Harper, Trung Huynh, Jo Walton and Matthew Weston PhD each certify, with respect to the companies or securities that the individual analyzes, that (1) the views expressed in this report accurately reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.

3-Year Price and Rating History for Merck KGaA (MRCG.DE)

MRCG.DE Closing Price Target Price Date (€) (€) Rating 17-Jun-13 61.55 63.00 N 10-Oct-13 56.55 61.50 05-Dec-13 65.25 69.00 20-Jan-14 65.98 71.50 23-Sep-14 73.22 82.00 15-Oct-14 67.12 77.00 14-Nov-14 74.29 81.00 09-Jan-15 82.29 88.00 O 16-Mar-15 105.90 115.00 07-Aug-15 90.78 108.00 15-Dec-15 88.32 104.00 * * Asterisk signifies initiation or assumption of coverage.

Target Price Closing Price MRCG.DE

1- Jan- 14 1- Jan- 15 1- Jan- 1650

75

100

125

N EU T RA LO U T PERFO RM

The analyst(s) responsible for preparing this research report received Compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activitiesAs of December 10, 2012 Analysts’ stock rating are defined as follows:Outperform (O) : The stock’s total return is expected to outperform the relevant benchmark* over the next 12 months.Neutral (N) : The stock’s total return is expected to be in line with the relevant benchmark* over the next 12 months.Underperform (U) : The stock’s total return is expected to underperform the relevant benchmark* over the next 12 months. *Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. For Latin American and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; prior to 2nd October 2012 U.S. and Canadian ratings were based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return potential within an analyst’s coverage universe. For Australian and New Zealand stocks, the expected total return (ETR) calculation includes 12-month rolling dividend yield. An Outperform rating is assigned where an ETR is greater than or equal to 7.5%; Underperform where an ETR less than or equal to 5%. A Neutral may be assigned where the ETR is between -5% and 15%. The overlapping rating range allows analysts to assign a rating that puts ETR in the context of associated risks. Prior to 18 May 2015, ETR ranges for Outperform and Underperform ratings did not overlap with Neutral thresholds between 15% and 7.5%, which was in operation from 7 July 2011.Restricted (R) : In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances.Volatility Indicator [V] : A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward.Analysts’ sector weightings are distinct from analysts’ stock ratings and are based on the analyst’s expectations for the fundamentals and/or valuation of the sector* relative to the group’s historic fundamentals and/or valuation:Overweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is favorable over the next 12 months.Market Weight : The analyst’s expectation for the sector’s fundamentals and/or valuation is neutral over the next 12 months.Underweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is cautious over the next 12 months. *An analyst’s coverage sector consists of all companies covered by the analyst within the relevant sector. An analyst may cover multiple sectors.

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Credit Suisse's distribution of stock ratings (and banking clients) is:

Global Ratings DistributionRating Versus universe (%) Of which banking clients (%)Outperform/Buy* 57% (37% banking clients)Neutral/Hold* 33% (24% banking clients)Underperform/Sell* 9% (44% banking clients)Restricted 1%*For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, and Underperform most closely correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis. (Please refer to definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdings, and other individual factors.

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Target Price and RatingValuation Methodology and Risks: (12 months) for Merck KGaA (MRCG.DE)

Method: We value Merck KGaA on a PE relative basis to the European markets, modulated by our PharmaValues NPV. Our European Specialty Pharma PE market-relative assumption is 160% and our a sector relative PE of 80%, giving a price target of EUR 104. Merck KGaA's 1 and 3 year historical average PE sector relative are 82% and 75% respectively. Our Outperform rating is based on the upside to our Target Price and expectations for mid-term EPS growth. Merck has a stable legacy Pharma portfolio with upside potential from avelumab, tipotinib, atacicept and PD-L1+TGFb in the pipeline. The integration of Sigma Aldrich in Life Science provides signficant revenue and costs synergies. In Performance Materials division offers limited top line growth but signficant cash flow at high margins to invest across the Group.

Risk: Risks to our Rating and Target Price include lower Erbitux or Rebif revenue or a failure of avelumab in clinical development. A dramatic increase in LCD competition with a more significant decline in profitability would also be a negative. Following the completion of the Sigma Aldrich transaction, any failure to deliver the EUR260m proposed synergies would also be a material negative.

Please refer to the firm's disclosure website at https://rave.credit-suisse.com/disclosures for the definitions of abbreviations typically used in the target price method and risk sections. See the Companies Mentioned section for full company names The subject company (MRCG.DE, LONN.S, LUN.CO, IPN.PA, UCB.BR) currently is, or was during the 12-month period preceding the date of distribution of this report, a client of Credit Suisse.Credit Suisse provided investment banking services to the subject company (LONN.S) within the past 12 months.Credit Suisse has managed or co-managed a public offering of securities for the subject company (LONN.S) within the past 12 months.Credit Suisse has received investment banking related compensation from the subject company (LONN.S) within the past 12 monthsCredit Suisse expects to receive or intends to seek investment banking related compensation from the subject company (MRCG.DE, LONN.S, LUN.CO, IPN.PA, UCB.BR, MEDAa.ST) within the next 3 months.As of the end of the preceding month, Credit Suisse beneficially own 1% or more of a class of common equity securities of (SHP.L, MEDAa.ST).As of the end of the preceding month, Credit Suisse beneficially own between 1-3% of a class of common equity securities of (LONN.S).For other important disclosures concerning companies featured in this report, including price charts, please visit the website at https://rave.credit-suisse.com/disclosures or call +1 (877) 291-2683. Important Regional Disclosures Singapore recipients should contact Credit Suisse AG, Singapore Branch for any matters arising from this research report.The analyst(s) involved in the preparation of this report may participate in events hosted by the subject company, including site visits. Credit Suisse does not accept or permit analysts to accept payment or reimbursement for travel expenses associated with these events.Restrictions on certain Canadian securities are indicated by the following abbreviations: NVS--Non-Voting shares; RVS--Restricted Voting Shares; SVS--Subordinate Voting Shares.Individuals receiving this report from a Canadian investment dealer that is not affiliated with Credit Suisse should be advised that this report may not contain regulatory disclosures the non-affiliated Canadian investment dealer would be required to make if this were its own report.For Credit Suisse Securities (Canada), Inc.'s policies and procedures regarding the dissemination of equity research, please visit https://www.credit-suisse.com/sites/disclaimers-ib/en/canada-research-policy.html.The following disclosed European company/ies have estimates that comply with IFRS: (LUN.CO, ORNBV.HE, UCB.BR).

20 May 2016


Credit Suisse has acted as lead manager or syndicate member in a public offering of securities for the subject company (LONN.S) within the past 3 years.As of the date of this report, Credit Suisse acts as a market maker or liquidity provider in the equities securities that are the subject of this report.Principal is not guaranteed in the case of equities because equity prices are variable.Commission is the commission rate or the amount agreed with a customer when setting up an account or at any time after that.To the extent this is a report authored in whole or in part by a non-U.S. analyst and is made available in the U.S., the following are important disclosures regarding any non-U.S. analyst contributors: The non-U.S. research analysts listed below (if any) are not registered/qualified as research analysts with FINRA. The non-U.S. research analysts listed below may not be associated persons of CSSU and therefore may not be subject to the NASD Rule 2711 and NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account.Credit Suisse International ..............................................................................Rebekah Harper ; Trung Huynh ; Jo Walton ; Matthew Weston PhDFor Credit Suisse disclosure information on other companies mentioned in this report, please visit the website at https://rave.credit-suisse.com/disclosures or call +1 (877) 291-2683.

20 May 2016


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