Merck Mauled on Drug Recall

Updated from 7:43 a.m. EDT

Merck (MRK Quote) shares staged a minor recovery early Friday after a 27% decline Thursday when the nation's No. 2 drugmaker said it was taking its arthritis drug Vioxx off the market because of heart safety concerns.

As a result, the company also said it was withdrawing third-quarter financial guidance and cutting its full-year earnings estimate by 50 cents to 60 cents a share.

The company said its decision to pull Vioxx voluntarily, which is effective immediately, is based on new, three-year data from a clinical trial. The trial, which is being stopped, was designed to evaluate the efficacy of Vioxx in preventing recurrence of colorectal polyps

Merck shares were up 49 cents, or 1.4%, to $33.49 Friday. On Thursday, they fell $12.07, or 26.8%, to $33 even, erasing about $25 billion from the company's market capitalization. Shares were down another 9 cents after hours. The stock had traded as low as $32.46 during the day. Some 139 million shares changed hands, about 27 times the average daily volume. The vicious selloff, however, may not reflect the company's fundamentals, given the drug's contribution to overall revenue, Merck's strong finances and the fact that analysts didn't rush to downgrade the stock.

During the study, researchers found an "increased relative risk for confirmed cardiovascular events," such as heart attack and stroke, beginning after 18 months of treatment in the patients taking Vioxx compared with those taking placebo.

Merck is pulling the product "because we believe it best serves the interests of patients," said Raymond V. Gilmartin, chairman, president and chief executive officer of Merck. "Although we believe it would have been possible to continue to market Vioxx with labeling that would incorporate these new data, given the availability of alternative therapies, and the questions raised by the data, we concluded that a voluntary withdrawal is the responsible course to take."

The company added that the results for the first 18 months of the polyp study "did not show any increased risk of confirmed cardiovascular events on Vioxx, and in this respect are similar to the results of two placebo-controlled studies described in the current U.S. labeling for Vioxx."

The Food and Drug Administration said Thursday that "the risk that an individual patient taking Vioxx will suffer a heart attack or stroke related to the drug is very small" and that its users should contact their physicians for guidance in discontinuing Vioxx and seeking other drugs.

Merck learned about the results on the evening of Sept. 23 from an external, independent safety monitoring board, a company spokesman said. Until then, the company wasn't aware of the results. After those results became known, the company held discussions with its own medical staffers and outside medical experts to plan the next step.

The FDA said Merck contacted the agency on Sept. 27 to request a meeting on the clinical trial. Merck and agency officials met Tuesday, and that's when the FDA said it was informed that Merck was withdrawing the drug. "Merck did the right thing by promptly reporting these findings to the FDA and voluntarily withdrawing the product from the market," said Dr. Lester M. Crawford.

"Although the risk that an individual patient would have a heart attack or stroke related to taking the drug is very small, the study that was halted suggests that, overall, patients taking the drug chronically face twice the risk of a heart attack compared to patients receiving a placebo," Crawford said.

Gilmartin told the CNBC financial TV network that five people taking a placebo died and five people taking Vioxx died during the clinical trial.

While Merck officials were meeting with the FDA, Gilmartin was meeting with his board of directors Tuesday to discuss the clinical trial and to recommend withdrawing the drug. Gilmartin told CNBC that the directors were "fully supportive" and "fully on board" with his recommendation to withdraw the drug.

Asked at a Thursday news conference whether he planned to resign, Gilmartin said he would not

Bad news has fallen hard on Gilmartin, who reaches mandatory retirement age of 65 in March 2006. The company cancelled research on four promising compounds last year, including late-stage tests on drugs for diabetes and depression; its Zocor anticholesterol drug, which accounted for 22% of corporate revenue last year, faces U.S. patent expiration in early 2006; and the company has been criticized on Wall Street for moving slowly to improve its pipeline through licensing deals.

Despite Merck's top-notch credit rating and strong reputation, its stock has been declining. It is reeling from the recent failure of several experimental drugs. And it is starting to feel the impact of patent expirations on important existing products. A recent study by the SG Cowen brokerage shows that among nine Big Pharma companies, Merck has 29% of 2003 revenue at risk due to product patents expiring between 2004 and 2008. The average generic risk among Merck's peers is 16% of 2003 revenue.

After the market closed, Standard & Poor's cut its outlook for Merck to negative from stable. However, the credit rating firm kept its highest-level AAA corporate credit and senior unsecured debt ratings for Merck.

"The ratings ... reflect its continued strong position in the pharmaceutical industry, despite the loss of Vioxx and the prospective loss of market exclusivity on the drug Zocor in the first half of 2006," said analyst Arthur Wong. "The company maintains a superior financial profile and a very conservative financial policy, and it continues to generate cash well in excess of ongoing needs."

Not everyone was so positive. The Vioxx withdrawal "was a disaster," said Sena Lund, of Cathay Financial, an investment research firm. "Merck has real problems." Lund doubts, however, that Gilmartin will be thrown overboard because he is too near mandatory retirement age and because it will take a long time to choose a successor. Experts in corporate management agree that dumping Gilmartin won't help the company.

A few weeks ago, Lund told The Street.com that he doubted Merck would make a big acquisition to improve its financial condition. On Thursday, he added that despite the plunge in the company's stock, he discounted the possibility that Merck would be a takeover target. "Why spend the money?" he said. (Lund has a neutral rating on the stock. He owns shares; his firm doesn't have an investment banking relationship.)

It appears that trial lawyers will be spending money. An Oklahoma City firm said it had filed a suit Thursday based on the Vioxx test results. Merck's most recent 10-K report said the company is subject to a number of Vioxx-related suits alleging injuries from side effects including heart problems and kidney damage. The lawsuits have been filed in federal courts and several state courts, Merck says. The company says these lawsuits are "without merit" and will "vigorously" fight them.

"We believe it's impossible to estimate the Vioxx litigation risk," said David R. Risinger, a Merrill Lynch analyst, in a research note to clients Thursday. But as a result of a likely spike in lawsuits, we think Merck is likely to expense more legal costs and take additional reserves over time."

Risinger, who has a neutral rating on the stock, said lawsuits "could overhang the Merck stock for an extended period," noting the experience of one of its industry rivals.

Risinger noted that Vioxx has been taken by 84 million patients whereas the diet drug fen-phen, made by Wyeth(WYE Quote) and withdrawn in 1996 because it was linked to heart valve damage, was used by only 6 million people.

He said Wyeth has taken $16 billion to $17 billion in charges and has paid out over $13 billion related to the lawsuits. Because litigation is continuing, Wyeth could incur more costs.

Risinger added that a "significant percentage" of Vioxx has been used short-term, "adding that "cardiovascular risks appeared to primarily result from long-term use." He added that it may be tougher to link Vioxx to a range of heart-related problems than it was to tie fen-phen to heart valve damage. (His firm is a market maker in Merck's stock and expects to seek or receive investment banking fees from Merck within the next three months. His report says "one or more analysts" responsible for the report owns shares in Merck.)

Needless to say, Merck received no mercy from the investment community. Morningstar was in the process of reviewing its 4-star rating and $53 fair value estimate on the stock, said Amy Arnott, a drug industry analyst for the Chicago-based research firm. (Five stars is the best rating). "We will revise it downward," said Arnott, who doesn't own shares and whose firm doesn't have a business relationship with Merck.

Although Merck had disputed some previous independent research on Vioxx, "the evidence was so clear that they didn't have a choice," she said.

"The Vioxx problem has been something that has been discussed for a long time," said Albert Rauch, an A.G. Edwards drug industry analyst, in a report to clients Thursday. "The difference with this trial is that it took the safety evaluation past 18 months of therapy." If the study had ended after 18 months, the results wouldn't have been negative, he explained.

"Other studies, including those used in the approval process by the FDA did not demonstrate an increased risk, although anecdotal evidence has started to show up," said Rauch, who kept his hold recommendation. (He doesn't own shares; his firm doesn't have an investment banking relationship.)

The bad news for Merck was good news for rival Pfizer (PFE Quote), which also markets a leading arthritis drug. Pfizer shares rose 22 cents, or 0.7%, to $30.40, while the Amex Pharmaceutical Index was down 2.9%.