Arthritis Drugs Put a Hurt on Merck and Pfizer

How Much More Pain for Merck?

Judging from their initial reactions, analysts seem torn between recommending Merck as a distressed stock price -- thanks to a strong balance sheet, what they believe is a safe dividend and their hopes for a turnaround in 2007 -- and telling clients to find something else because the stock might be affected by lawyers and regulators. Three investment banking firms have raised their ratings on Merck since the Vioxx announcement, and two have cut their ratings. All five now have neutral ratings on Merck, as do most other analysts.

One immediate concern is what happens to Arcoxia, the next-generation COX-2. After Merck pulled Vioxx, the company reaffirmed its desire to seek regulatory approval for Arcoxia in the U.S. The drug is available in 47 countries and is under review by the Food and Drug Administration. The FDA is scheduled to respond in late October.

Merck officials say they will continue pursuing the marketing of Arcoxia, arguing, just like Pfizer has done, that tests of one COX-2 drug cannot be extrapolated to another. Merck said last week that it will work with regulators in the 47 countries "to assess whether changes to the prescribing information ... are warranted."

That didn't offer much encouragement to Mara Goldstein of CIBC World Markets, who is neutral on Merck. "The prospect of Arcoxia [is] greatly diminished, in our view," she wrote to clients a day after Merck said it was removing Vioxx from the market. Noting that safety data longer than 12 months "is not readily available," Goldstein said she doubted the FDA would approve the drug at this time. "Even with approval, the commercial potential is likely to be seriously blunted until such data is available," she said.

Goldstein said she was removing potential U.S. sales of Arcoxia from her earnings model until 2007. (Her firm says it seeks or expects to receive investment banking compensation from companies covered in research reports; she owns shares in Merck.)

Another source of potential pain is litigation. Although some analysts have pointed to the heavy legal expenses incurred by Wyeth(WYE Quote) in settling lawsuits related to the fen-phen diet drugs, analysts say Merck's legal situation is murky.

"Liability concerns are overblown, but expect [the] topic to continue to negatively impact valuation," said Joseph P. Riccardo, of Bear Stearns, in an Oct. 1 research report, as he raised his rating to peer perform from underperform. His new rating "means don't sell" because the dividend "is relatively secure and [the] balance sheet is strong."