When it comes to investing in
, don't panic and don't sell the shares just because the company lost its first Vioxx case.
This prevailing Wall Street advice was largely ignored on Friday after a Texas state court jury voted to support a wrongful death claim against Merck, assessing $24.4 million in actual damages and $229 million in punitive damages. The stock sank nearly 8% to $28.06, as 38.4 million shares -- four times the daily average -- were traded.
"Investors are overreacting," says Michael Krensavage of Raymond James, in a report to clients. "Appellate courts
are likely to squelch Vioxx hysteria."
Few analysts are as emphatic as Krensavage, who reaffirmed a strong buy rating on Merck on Friday, but the consensus suggests that investors wait to see what happens with several upcoming cases -- and Merck's appeal of the Texas case -- before bailing out of the stock. If you want to sell or avoid the stock, they add, do so because of Merck's fundamentals rather than because of one jury verdict.
On Monday, however, investors were sending the stock down 61 cents, or 2.2%, to $27.45 after about two hours of trading. The stock fell as low as $27, and trading was nearly triple the average daily volume for the last three months.
"We do not think investors should apply this ruling to the thousands of cases Merck faces," says David Risinger of Merrill Lynch, in a report to clients. He argues that the trial took place "in a particularly plaintiff-friendly jurisdiction" and that the $229 million punitive damage award is way above the amount permitted by state law. "The ruling could be overturned on appeal, or the award amounts could be reduced significantly," he says.
In the Thousands
Whether the district is "plaintiff-friendly" is a continuing debate, with a number of Wall Street analysts saying it is and as many lawyers saying it isn't. At any rate, Risinger said in a Friday research report that the Texas case likely will encourage more people to sue Merck. As of June 30, the company was a defendant in 4,100 personal injury lawsuits, involving 7,500 plaintiff groups, plus 120 class-action personal injury lawsuits.
The company is subject to lawsuits alleging securities law violations and violations of laws governing retirement plans. Merck hasn't quantified the number of lawsuits that have been filed outside the U.S.
Risinger says the precise number of U.S. lawsuits won't be known until after September 2006, which marks the two-year statute of limitations for filing a claim. Merck announced on Sept. 30, 2004, that it was withdrawing Vioxx from U.S. and foreign markets.
Merck said it acted after results of a clinical trial showed that Vioxx users, who took the drug for more than 18 months, had greater cardiovascular risks than people who had taken a placebo. There was no statistically significant difference in risk between the two groups prior to 18 months. Critics allege the company knew several years earlier that Vioxx posed problems.
"Merck's win-loss ratio in the next half-dozen or so trials is likely to drive investor sentiment regarding the company's theoretical liability," Risinger says. "Investors want to see whether or not juries conclude that Vioxx caused cardiovascular events and what size punitive damages are awarded."
Like most analysts, Risinger has a neutral rating on Merck. According to Thomson First Call, 20 analysts are neutral, two have sell recommendations and five have buy ratings.
The big jury verdict didn't change anyone's opinion on Friday, but on Monday, Catherine J. Arnold of Credit Suisse First Boston raised her rating to neutral from underperform. She changed her view because the stock had been knocked down close to her $27.50 target price.
A similar note was issued by Steve Scala of SG Cowen, who told clients on Monday that Merck is "unappealing on fundamentals alone, not Vioxx risk."
Although the Texas verdict will encourage
more lawsuits, and more lawsuits will force Merck to increase litigation reserves, Scala says investors should avoid Merck due to a "lackluster pipeline and major patent expirations every two years at least through 2012." Merck has set aside $675 million in reserves to handle litigation expenses, but it hasn't identified reserves to cover settlements or unfavorable verdicts.
The big patent expirations, Scala adds, are the cholesterol drug Zocor in 2006; the osteoporosis drug Fosamax in 2008; the Cozaar/Hyzaar blood pressure medication in 2010; and the asthma drug Singulair in 2012. "We view Merck shares as unappealing," he concludes.
Protecting the Dividend
Scala says the company's dividend looks safe -- an assessment that Merck bulls, bears and fence-sitters share. How safe and for how long is a topic for debate.
Scala says the current dividend of $1.52 a share looks good through 2010. Arnold says the dividend looks safe for one to two years. The yield is 5.4%, and her $27.50 target price assumes a yield of 5.5%, which she says is at the top end of the historical range for Big Pharma companies.
Krensavage backs his strong buy rating because the dividend yield "helps support the stock while the investors wait for a pipeline of new products." Another Merck bull, Robert Hazlett of SunTrust Robinson Humphrey, told investors on Friday that his buy rating is bolstered by a "robust" dividend yield.
Even though earnings growth is "likely to be flat for a few years," the dividend "should materially aid total return during this time, and we believe it should remain intact near term," Hazlett says. However, if Merck continues to lose big Vioxx cases, it may have to cut the dividend, he adds.
Merrill Lynch is a market maker in Merck's stock and has had an investment banking relationship with the company. Credit Suisse First Boston has had an investment banking relationship. The other firms either have had no relationship or say they expect to seek or do business with companies mentioned in their research reports. Among analysts quoted, none owns shares of Merck except at SG Cowen where the firm says "the author(s) and/or members of their households" own Merck shares.