Just about any time a Merck ( MRK) executive appears before a microphone, presides over a Webcast or attends a financial or medical conference, he or she is asked how safe the dividend is. The question has been posed ever since Sept. 30, 2004, when Merck pulled the arthritis drug Vioxx from the market, and every time the New Jersey-based drugmaker says its payment isn't in danger. However, investors can expect this Q&A to continue, perhaps for years, as long as there's uncertainty about potential liabilities of Vioxx. Wall Street estimates of those liabilities run as high as $55 billion. But the dividend is only part of the financial dilemma for Merck, which is facing several years of declining earnings per share and sales growth. Merck doesn't have enough new drugs with large-sales potential to offset the lost revenue from big-sellers going off patent, but don't expect any drastic dividend action soon. Merck still has a healthy credit rating. The company's balance sheet also has been bolstered, thanks to a law signed by President Bush last year that enables companies to repatriate earnings from foreign subsidiaries at sharply reduced tax rates. Merck is repatriating $15 billion. Still, there's that nagging question. Merck's yield of 5.1% -- second-highest among its peers -- has been attractive to investors willing to wait out the bad times. They might be waiting a while, according to Albert Rauch of A.G. Edwards. "Our concern is that it will be a long time for the turnaround -- 2008, or even 2009 or 2010," he says.
Right now, the dividend is propping up the stock. Rauch says Wall Street is valuing Merck for its ability to maintain the payout rather than its earnings per share performance. Clearly, a dividend cut would send Merck's shares lower. If the price fell too low, Merck could even become a takeover target, says Rauch, who doesn't own shares and whose firm doesn't have an investment banking relationship with the company.
Stock SupportCutting the dividend would scare investors because they might interpret the move to mean that Merck fears big Vioxx litigation losses, Rauch says. Merck hasn't established a reserve for potential liabilities, but it has set aside $675 million just for legal expenses.
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He figures Merck can maintain its current dividend from existing cash flow as long as the Vioxx liabilities stay below $25 billion. Anything higher and the dividend would be at risk, he says. Merck lost a Texas state court case in August, then won a New Jersey state court case in November. The first federal court case is under way in Houston. As of Sept. 30, more than 6,400 U.S. lawsuits have been filed alleging that Vioxx caused injury or death. During Merck's Nov. 28 conference call to
explain its restructuring plan , one analyst asked if Merck might raise the dividend. Judy Lewent, the company's chief financial officer, repeated the mantra that Merck has sufficient cash flow to support the dividend at its current level. For many years, Merck investors could count on a dividend increase annually. Most recently, a penny a share was added every October -- but not this year, with the quarterly payout remaining at 38 cents. dividend announcement . At the time, the yield was about 4.4%, and investors had been getting yearly dividend increases, even as the company's financial condition was deteriorating.
Not Schering-PloughThe only Big Pharma dividend-cutter in recent memory was Schering-Plough ( SGP) in 2003, and its financial condition was dramatically worse than Merck's is now. Merck's long-term credit rating is still much better than Schering-Plough's. A few months after Fred Hassan took over as Schering-Plough's CEO in April 2003, he chopped the quarterly dividend to 5.5 cents from 17 cents as part of a massive cost-cutting program. The payout remains at 5.5 cents. "The previous dividend level is not realistic given the company's reduced revenues, the need to conserve cash for inherited regulatory and legal issues, and the need to invest for future growth," Hassan said on Aug. 21, 2003, in his
Merck still gets high marks from credit-rating firms. At Moody's Investors Service, for example, Merck ranks No. 4 among 21 drug companies. Moody's looks at many factors to develop its credit ratings, and Merck's free-cash-to-debt ratio is still in the high-grade range, says the agency's Michael Levesque. The operating-cash-to-debt ratio, which excludes dividends, still qualifies for a top rating, he says. Levesque says Merck's "Aa3" rating should hold this year and next as long as the company can generate $1.5 billion in free cash flow annually and keep the Vioxx liabilities under $10 billion. The key to the near-term rating is the Vioxx litigation, Levesque says.
Dividend DilemmasAnother type of lawsuit is weighing on the dividend strategy at Bristol-Myers Squibb ( BMY), which has the highest yield among its peers and a weaker credit rating than Merck. Like Merck, it suffers from too many big-revenue drugs losing, or about to lose, patent protection, and few promising replacements on the horizon. Bristol-Myers is awaiting a trial challenging its U.S. patent for its biggest drug, the anticoagulant Plavix. A court date has been set for April 2006. The company and its partner Sanofi-Aventis ( SNY) are fighting two generic drugmakers that are trying to invalidate a patent that runs into 2011. "An adverse outcome would cause us to re-evaluate operational and financial needs, including the dividend," says Jeffrey Schoenborn, a Bristol-Myers spokesman, whose company is developing contingency plans for a Plavix ruling. Plavix produced $980 million in third-quarter sales, or 20% of corporate revenue. The quarterly payout is 28 cents a share, a level it has held for four years. Meanwhile, Bristol-Myers remains in the Wall Street doghouse, as only one out of 25 analysts who cover it has a buy rating, according to Thomson First Call. Litigation made Wyeth ( WYE) face a dividend decision in the late 1990s and early 2000s because of legal liabilities related to the diet drugs Pondimin and Redux, which were withdrawn from the market in 1997.
When the diet-drug lawsuits started, "we didn't have a sense of how much it
the cost would be," says Ken Martin, Wyeth's chief financial officer. The diet-drug litigation reserve has since climbed to $21.1 billion. By the end of 1999, when Wyeth set aside the first reserve of $4.75 billion, Martin says executives "didn't feel comfortable" about the potential impact of lawsuits on the dividend and the company's ability to meet research, development and capital investment goals. "Each year, we had to reassess," he adds. But Wyeth was aided by strong operating results and some good timing. The company, then known as American Home Products, got a $1.8 billion breakup fee when Pfizer ( PFE) outbid it for Warner-Lambert in 2000. Also that year, Wyeth sold its agricultural chemicals business to Germany's BASF ( BF) for nearly $4 billion. A year later, Wyeth benefited when Amgen ( AMGN) made a $16 billion bid for the biotechnology firm Immunex, in which Wyeth owned a 41% stake. "If those events didn't happen, our view of paying the dividend would have been different," Martin says. "We did not sell any business to get cash to fund the diet drug litigation." Even so, Wyeth stopped raising the dividend at the end of 1999. For the next six years, the quarterly payment was 23 cents. On Dec. 1, Wyeth paid 25 cents as a reward to shareholders, Martin says. "The uncertainty level has declined," he explains. "Our management and board are saying that we are comfortable with our cash position, the diet drug litigation and the needs of our company."