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Merck: How Much Misery After Vioxx?


Rarely has a painkiller caused so much pain. Since Merck & Co. (MRK) withdrew its blockbuster drug Vioxx in September, the bad news hasn't let up. A big blow came on Nov. 8, when Merck disclosed it had been subpoenaed as part of a Justice Dept. investigation into research, marketing, and sales activities related to Vioxx. The Securities & Exchange Commission has also begun an informal inquiry into the matter. The following day, bond ratings agency Moody's Investor Service (MCO) downgraded Merck's long-term debt. Those moves come even as Merck faces hundreds of lawsuits, and the prospect of hundreds more, related to the painkiller, which was pulled from the market after a study confirmed earlier fears that it was linked to an increased risk of heart attack.

So how bad might this get for once-mighty Merck? While it's impossible to say precisely what the Vioxx debacle will cost the drugmaker, analysts' estimates range from a few billion dollars to nearly $20 billion. For now, Wall Street and some plaintiffs' lawyers agree that the Vioxx fallout is unlikely to lead to a Merck bankruptcy. That view, of course, could change if the Justice probe uncovers evidence of criminal wrongdoing; then, all bets are off. "I think they can survive it," says Edwin C. Ciskowski, an analyst at Lincoln Equity Management Co. "But they will limp along, and Merck will be a very unattractive stock for many years."

Merck General Counsel Kenneth C. Frazier says the company has acted responsibly and that "it is not conceivable" that Vioxx suits could threaten its viability. Frazier says Merck will oppose any move to consolidate the cases into a class action -- something legal experts say the courts may support due to the differences among many plaintiffs. Instead CEO Raymond V. Gilmartin and his team aim to defend Merck vigorously against the cases individually, focusing on each plaintiff's medical history, the injury they may have suffered, and whether there is proof Vioxx was the actual cause. That strategy may be watched closely at rival Pfizer (PFE), whose painkiller Bextra has come under scrutiny for possible cardiovascular problems of its own.

HUGE BILL

But make no mistake, despite Merck's hard-line approach, the legal bill is likely to be considerable. Merrill Lynch & Co. (MER) analyst David R. Risinger did an analysis of the potential liability based on the fact that 20 million Americans had taken Vioxx since its approval. He drew on a study by Kaiser Permanente earlier this year that showed that roughly 0.25% of those who took the drug had serious cardiovascular problems. That means some 50,000 people may have suffered consequences. Assuming that the size of average awards or settlements will range from $100,000 to $300,000, he then factored in other variables such as the likely success rate in court and added in other legal costs -- including settling suits where Vioxx users didn't suffer a major cardiovascular event. The total hit: as low as $4 billion, as high as $18 billion.

But even that $18 billion figure may prove conservative. Risinger warns that if criminal wrongdoing surfaces, in a worst-case scenario the cost could go even higher. "That increases the likelihood and magnitude of punitive damages," says Arnold Levin, senior partner with Levin, Fishbein, Sedran & Berman, who represented plaintiffs in the class action surrounding the diet drugs Pondimin and Redux. If the Justice Dept. probe results in criminal indictments, analysts warn, the company's survival could be threatened.

Merck, however, does have several factors that should give it decent odds of pulling through. For one thing, the drugmaker generates free cash flow of more than $1.5 billion a year, even after spending more than $3.5 billion on research & development, and another $3 billion on its dividend. It could strengthen its cash position by cutting that payout. Merck insists it won't touch the dividend; its battered stock, which has fallen more than 40%, to $26, since Vioxx was recalled, would suffer even more. For now, analysts figure such a move would be premature, since the ultimate Vioxx liability is unclear. While Merck's borrowing costs will rise in the wake of Moody's downgrade of its long-term debt from Aaa to Aa2, SG Cowen analyst Stephen M. Scala says that is unlikely to be a huge drag on cash flow.

It helps that Merck's balance sheet is solid, with $7 billion in cash and short-term investments. In addition, Merck and AstraZeneca have outlined plans to dissolve a partnership formed in the 1980s. Scala says that if Merck dissolves the partnership, it could pocket payments of $9 billion or more by 2010, though that will hurt earnings as Merck loses its cut of sales of AstraZeneca products. Scala also figures that Merck could get the money faster, if needed, by agreeing to cut its price.

Another factor in Merck's favor: The legal wrangling over Vioxx is likely to go on for years. That means Merck will have a long time to pay the bill. Consider Wyeth: (WYE) Since withdrawing Pondimin and Redux in 1997, the company has reserved $16.6 billion against its earnings for costs related to lawsuits and has not come close to insolvency.

Given how beaten down Merck's stock is, some investors might begin hoping that another drugmaker will swoop in and buy the company. That's unlikely. Investment bankers agree Merck's liability is simply too uncertain. "I don't think anybody would want to take this on," says one. The more likely prospect is a company that faces distraction and a financial drain for a long time to come.

By Amy Barrett in Philadelphia


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