Robert Steyer

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Merck Still Murky

Robert Steyer

Lose one, win one. Two down, and more than 6,400 to go.

About the only thing certain after Thursday's New Jersey state court verdict favoring Merck (MRK Quote) and its arthritis drug Vioxx, is that there will be more uncertainty.

"Quantifying Merck's total liability still remains an exercise in futility," says Tim Anderson of Prudential Equity Group in a Thursday research note. "The whole issue will take years to play out."

The Atlantic City, N.J., jury said Vioxx didn't cause an Idaho postal worker's heart attack. The jury also said Merck didn't commit consumer fraud in marketing Vioxx to physicians.

Merck withdrew the drug from the market Sept. 30, 2004, after a company-sponsored clinical trial showed long-term use could increase the risk of cardiovascular injury or death.

Although Merck's stock rose following the decision, bond and stock analysts cautioned against building long-term hopes on one verdict.

"In our amateur legal opinion, this was not a strong case [vs. Merck] on medical grounds and should not be viewed as having tremendous legal ramifications for Merck's longer-term legal risk," says Carol Levenson, director of research for the independent bond research service Gimme Credit, in a research report.

Moody's Investors Service kept its "high-grade" Aa3 long-term credit rating on Merck, but it also retained a negative outlook "primarily because of concerns that Vioxx litigation costs may be extremely high." The favorable verdict alleviated "near-term rating pressure" that would have been triggered if Merck lost the case.

The New Jersey verdict certainly helped Merck, but because there are at least 6,400 personal injury cases in state and federal courts, the company still faces "significant risk for negative outcomes," says Albert L. Rauch of A.G. Edwards in a report to clients. "We expect Merck to be highly volatile on negative and positive outcomes of cases going forward."

Merck's stock was volatile Thursday. After the verdict was announced, the stock spiked to $30.90, but by the end of the day, it closed at $29.48, up $1.07, or 3.8%. Volume of roughly 38.1 million shares was nearly four times the average daily trade for the past three months.

Impossible to Project

Wall Street's uncertainty is illustrated by Rauch. Heading into the New Jersey jury deliberations, he thought Merck would lose the case based on testimony and his belief that the company's lawyers "did little to modify their strategy" from the case it lost in Texas, he said in a Nov. 1 report.

In August, a Texas state court jury awarded $253.4 million in actual and punitive damages to the wife of a man who died of a heart attack. The man took Vioxx for about eight months, and the jury linked his death to the drug.

Merck will appeal. Even if it loses the case, Merck's penalty will be reduced by at least 90% because the jury's award far exceeded the state's limit on punitive damages.

After the New Jersey verdict on Nov. 3, Rauch said that despite the good news for shareholders, "it is still too early to know if Merck will be able to win cases on a consistent basis in New Jersey courts, other state courts or in federal courts." The first federal court case, in which rules of evidence are stricter than in state courts, starts Nov. 28 in Houston.

Rauch has a hold rating on Merck. He doesn't own shares, and his firm doesn't have an investment banking relationship. The New Jersey verdict also doesn't affect his less-than-enthusiastic view that Merck is a company with a "lack of earnings growth, weak [research] pipeline, damage to its reputation and litigation risk," plus the mid-2006 U.S. patent expiration of the cholesterol drug Zocor, its best-selling product.

One analyst with a more emphatic view about Merck's litigation and share-price prospects is Michael Krensavage of Raymond James, who reaffirmed his strong buy rating.

"Litigation concerns are overblown," he tells clients in a research report. He doesn't own shares, but his firm says it intends to receive or seek investment banking related compensation from Merck within three months.

The latest verdict "underscores a key point to our thesis," Krensavage says. "Plaintiffs will have a difficult time proving Vioxx caused their heart attacks. This is because most people have other risks such as obesity, high blood pressure or high cholesterol."

Krensavage says a primary issue for upcoming trials will be how many plaintiffs took Vioxx at recommended doses consistently for more than 18 months. That's the cutoff point at which a Merck-sponsored clinical trial showed statistically significant cardiovascular risk between people taking Vioxx vs. those receiving placebo. That's also the clinical trial that prompted Merck to withdraw Vioxx on Sept. 30, 2004.

Critics say other tests showed that Vioxx exhibited signals of cardiovascular risk much earlier than 18 months.

The late Robert Ernst, whose family sued and won in Texas, took Vioxx for eight months. Frederick Humeston, who lost the New Jersey case, took the drug for about two months.

Kenneth C. Frazier, Merck's general counsel, said Thursday that he had "no reliable information" on how many plaintiffs took Vioxx consistently for more than 18 months but he believes most took the drug for less than that.

Frazier reiterated the company's strategy that it will litigate every case. If juries evaluate the science and find Merck provided information "fully and promptly" to doctors and regulators, the company will win future cases, he said.

Where to Compare

Court fights are expensive, but Frazier said Merck still isn't setting a reserve of potential liabilities. Such a reserve is "not appropriate now," he said. Although the company monitors litigation expenses, it's sticking with its $675 million reserve for legal expenses for now.

Analysts' estimates for Merck's legal bill run as high as $55 billion, but most keep their estimates under $20 billion. Prudential's Anderson predicts Vioxx will cost less than fen-phen, which has sucked out about $23 billion from Wyeth (WYE Quote). Anderson, who has a neutral rating on Merck, doesn't own shares. His firm doesn't have an investment banking relationship with Merck.

Fen-phen is the diet drug cocktail that was linked to heart valve damage and other dangerous cardiovascular problems in the late 1990s. Wyeth made Pondimin, which created the fen-phen cocktail when combined with the non-Wyeth drug phentermine. Wyeth pulled Pondimin and another diet drug, Redux, from the market in 1997.

Krensavage sees some financial comfort for Merck in, of all things, tobacco litigation.

Even if Merck lost the New Jersey case, "appeals would have delayed any payments for years," he says. Altria Group's (MO Quote) Philip Morris USA division has paid $20 million in two suits involving ill smokers, he says, and each case lasted seven years until the tobacco company ran out of appeals.

Merck is taking an Altria-like approach by defending each case rather than pursuing a group settlement, Krensavage says. "While Merck defends itself, it benefits from free cash flow of more than $5 billion a year," he says.

The New Jersey case also resurrected a question that Merck hasn't answered since early this year and probably won't for some time: Will it try to bring Vioxx back to the market?

In February, an advisory committee to the FDA recommended that Vioxx could be returned to the market for certain patients under certain circumstances. The vote was 17-15. The FDA usually follows its advisory panel's recommendations.

Right now, the point is moot because Merck would have to resubmit a Vioxx application. On Thursday, Frazier repeated earlier statements that Merck is discussing the matter with regulators but hasn't made a decision on whether it will seek to reinstate Vioxx.