People looking for a little irony in their investments are getting an overdose with

Teva Pharmaceutical Industries

(TEVA) - Get Report

, the world's largest maker of generic drugs.

Teva has thrived on making reduced-price versions of drugs whose patents have expired, but the manufacturer of one of the biggest brand-name drugs is now giving the Israel-based company a taste of its own medicine by undercutting its pricing strategy.

Merck

(MRK) - Get Report

has signed an unusual deal with a managed care company that will enable customers to pay less out-of-pocket for brand-name Zocor, the cholesterol-fighter, than they would for Teva's generic version. Zocor is Merck's biggest product, and its U.S. patent expires Friday.

Teva's stock fell by 9.5% on Wednesday when

The Wall Street Journal

reported Merck's deal with

UnitedHealth Group

(UNH) - Get Report

. Nearly 40 million shares were traded, or more than six times the daily average for the past three months.

On Thursday, Teva's stock continued to drop as Robert Uhl of Friedman Billings Ramsey cut his rating to market-perform from outperform. By early afternoon, the stock was down 67 cents, or 2.1%, to $31.60, again on heavy trading. The stock dropped as far as $29.83, just slightly above Teva's 52-week low.

The Merck deal "signals a new battlefield in the price competition war that generic industry participants will have to face," Uhl writes in a research note. "We do not know if the arrangement will spread to other prescription benefit plans or to other brand companies." Uhl, who doesn't own Teva's shares, cut his 2006 earnings prediction by 5 cents a share to $2.05.

Unique Situation

Other analysts see the Merck's Zocor strategy as a one-shot deal, due to the drug's size -- $3.14 billion in the U.S. last year and $1.24 billion in foreign markets.

For example, without much fanfare, Teva recently received approval from the Food and Drug Administration to sell a generic version of Merck's Proscar for treating an enlarged prostate. The company also got clearance for a generic version of

Bristol-Myers Squibb's

(BMY) - Get Report

cholesterol drug Pravachol.

"Although there are multiple unknowns, at this point, we believe that generic Zocor is a unique situation and we do not expect Merck's strategy to be adopted by other branded players," William Sawyer of Leerink Swann wrote in a Wednesday report. Sawyer, who maintains an outperform rating on Teva, doesn't own shares.

Analysts note that brand-name companies routinely make price concessions to managed-care firms in order to keep their drugs on the firms' formularies, which are the lists of recommended drugs. Brand-name drugs can remain on formularies even when they lose patent protection and compete with generics.

Merck's deal with UnitedHealth was unusual because the managed-care firm will place Zocor in a price category reserved for generic drugs and put Teva's drug in a category for brand-name drugs. Generic drugs normally carry lower out-of-pocket payments for patients, but not in this case.

"We do not believe that this move has major implications to Teva specifically, or to the industry generally, since we do not believe this will be widespread," Ken Cacciatore of S.G. Cowen contended in a research report. "Merck has treated Zocor uniquely from the outset."

Following the UnitedHealth arrangement, health-benefits company

WellPoint

(WLP)

agreed to offer name-brand Zocor, and not generics, by way of its mail-order pharmacy, the

Journal

reported. WellPoint said it will charge $10 for a 30-day Zocor supply, the report said.

Cacciatore adds that Teva's management indicates that the Merck deal "does not alter" its previous guidance of generic Zocor adding $250 million to $300 million in sales this year and 20 cents to 25 cents a share in earnings. Cacciatore, who is neutral on Teva, doesn't own shares.

More Challenges

Teva may be facing even more financial uncertainty as the Zocor patent expires.

Under normal circumstances, Teva would get a six-month head start on other makers of generic Zocor thanks to the federal "first-to-file" law. The law rewards companies for making the earliest proper application to the FDA for selling a generic drug after a brand-name patent expires.

Because generic drugs have narrow profit margins, six months can be a big payday, even for a giant like Teva that had $5.3 billion in sales last year. Considering that Zocor represents the biggest drug-patent expiration in U.S. history, the exclusivity is especially rewarding.

But as Teva approaches the Friday deadline for Zocor, it won't get the full benefit of the first-to-file law. That's because several months ago, Merck licensed Zocor to the generic company

Dr. Reddy's Laboratories

(RDY) - Get Report

, enabling it to sell it a low-priced version of the drug after the patent runs out.

By authorizing Dr. Reddy's to sell generic Zocor, Merck saved the Indian drugmaker the cost of getting FDA approval. Dr. Reddy's will pay a sales-based royalty to Merck, softening the blow of lost brand-name Zocor revenue. At the same time, it hurts Teva by adding another competitor.

Deals of this type are becoming more common, even as generic companies complain the practice of "authorized generics" discourages their efforts. So far, the FDA, the courts and Congress haven't opposed authorized generics, although the Federal Trade Commission is studying the practice.

Legal Issue Remains

Teva also remains tangled in litigation with the FDA over the six-month exclusivity period. In what can charitably be called a complex case, the agency ruled in October that Teva wasn't entitled to the six-month exclusivity for four dosage strengths of generic Zocor.

Teva sued the FDA, and a federal district court judge issued a summary judgment in the company's favor on May 1.

The judge said the FDA acted improperly and sent the matter back to the agency. The FDA has appealed, but the case won't be heard for several months.

Analysts aren't sure what the FDA will do next. "We expect more headlines Friday," says David Woodburn, of Prudential Equity Group in a research report. He predicts Teva will get the regulatory go-ahead to start marketing four Zocor strengths, "though the possibility exists that the FDA could hold up approval" until the appellate court rules.

Woodburn adds that "it's also possible" that another generic company could sue to halt all FDA approvals of generic Zocor until the FDA appeal has been heard. Several companies have received tentative approval from the FDA for selling generic Zocor, but they have to wait until Teva's six-month exclusivity period expires.

Woodburn says India's

Zydus

filed a petition in support of the FDA's appeal against Teva. "We don't know if Zydus feels strongly enough to file a lawsuit," says Woodburn, who has an overweight rating on Teva. He doesn't own shares of the company.