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The Pain Is Just Beginning


Another corporate icon has been humbled. Long a Big Pharma powerhouse, Merck & Co. now looks likely to emerge from its Vioxx mess as a weakened version of its former self: a second-tier player among its rivals.

The fallout from the Aug. 19 Texas jury verdict is only beginning. The $253 million award is likely to bring on a torrent of new lawsuits, even as another ominous cloud gathers: The Justice Dept. is continuing a criminal investigation into Merck's handling of Vioxx. Should the probe result in convictions of current or former Merck executives, the odds of big punitive-damage awards in civil cases would increase. Then there's the biggest wild card of all: Do Vioxx users have an increased risk of heart attacks even after they stop taking the drug? While doctors say that's unlikely, data from a company study could show otherwise, potentially ballooning the number of plaintiffs and even jeopardizing the company's survival.

When Merck's team of lawyers began their opening arguments in a Texas courtroom in mid-July, they thought science would vindicate the company. Sure, Vioxx had been linked to heart attacks and strokes, which was why Merck stopped selling its blockbuster pain pill last fall. But there was no evidence, they argued, that Vioxx could have killed Robert C. Ernst, a 59-year-old triathlete who died in his sleep in 2001 after taking the drug for eight months. Just look at Ernst's autopsy, they said. The coroner concluded the cause of death was an irregular heartbeat known as an arrhythmia.

It turned out, of course, to be a costly misjudgment. A jury voted 10-2 that the arrhythmia likely was brought on by a clot and a sudden heart attack, and for that, Merck should richly compensate Ernst's widow, Carol Ernst. Merck will almost certainly see the massive verdict reduced and has a decent shot at prevailing in an appeal. But the decision is ominous. Ultimately, some analysts estimate that Merck's liability could soar to $50 billion.

FADING FASTER

Investors were fretting well before the Texas verdict. Merck's biggest seller -- cholesterol-lowering drug Zocor, with forecast sales of $4.4 billion this year -- loses its patent protection next year. Now, management distraction and the financial toll of settling Vioxx suits seem likely to make it harder for Chief Executive Richard T. Clark to attract the best scientists or tie up with outside companies for products to make up for that loss. "Even without Vioxx, Merck was fading," says Lloyd S. Kurtz, portfolio manager at Palo Alto (Calif.)-based Nelson Capital Management. "Now maybe they fade faster."

Merck executives dismiss such talk, arguing that the company is as strong as it ever was. Merck's general counsel Kenneth C. Frazier says estimates of the number of suits and Merck's potential liability are "highly speculative." He adds that while the company didn't make its best case in Texas, management acted responsibly in its handling of Vioxx. "I don't see this as an issue that in any way cripples our mission going forward," Frazier asserts.

Certainly, Merck can withstand a sizable hit. The Whitehouse Station (N.J.) company had $14 billion in cash and investments as of June 30. Even at today's post-verdict stock price of almost $28 a share, Merck maintains a market capitalization of $60.5 billion. Merrill Lynch & Co. (MER) analyst David R. Risinger figures Merck will throw off $1 billion or more in cash after paying its dividend this year and in 2006. And the company could free up more bucks if it decides to cut that $3.3 billion annual dividend. While Merck has said it is committed to maintaining its dividend, Nelson's Kurtz says that payout is probably "unsustainable."

A dividend cut would be hard to avoid if Merck can't turn the tide in the courtroom. Right now investors and industry experts are flabbergasted that the company's lawyers did not effectively address the paper trail in the Texas case. Among the most damning exhibits: a 2000 memo that said a key study seemed to confirm fears about cardiovascular problems. Merck's Frazier says such memos reflect the fact that some data did raise initial concerns about Vioxx' cardiovascular safety. But he says subsequent analysis of other studies allayed those concerns. Next time, he says, Merck lawyers must explain that better to jurors. But he says Merck will continue to defend each case individually and will not negotiate a global settlement.

Even if Merck can manage to rack up some wins, many on Wall Street are bracing for a huge bill. Analyst Richard T. Evans of Sanford C. Bernstein & Co. (AC) estimates that the number of plaintiffs could easily hit 65,000. Under that scenario, and looking at the average payout in cases that involve heart attacks, damages could hit $30 billion. But that number may prove conservative if plaintiff's lawyers pile on with cases like Ernst's that don't involve proven heart attacks. Add in the increased likelihood of punitive damages, and the bill could go as high as $50 billion, says analyst David Moskowitz of Friedman Billings Ramsey.

LOOMING STUDY

But Merck's dilemma may be even more complicated. The company is still tracking the health of patients in a study it stopped last September when it pulled Vioxx. The company will begin collecting and analyzing data on those patients later this fall, although the company says it does not know when the follow-up information from that study, called APPROVe, will be ready for release. The key question is whether the risk from taking Vioxx persists for some period after people stop taking the drug.

Dr. Robert S. Bresalier, a member of the steering committee that led the APPROVe trial, says he suspects there is no lingering risk, and investors are betting he's right. But given the scientific uncertainties about exactly why Vioxx heightens the risk of heart attack, Bresalier says there is no way to be sure until the data are in. If there is some ongoing risk, Moskowitz of Friedman Billings Ramsey warns that the pool of plaintiffs could expand alarmingly. That, he says, could "call into question the survival of the company." Frazier says the company can't speculate on what that data will show but reiterates the company is financially strong.

When it comes to the Texas case, few people expect Merck to fork over anything close to $253 million. For one thing, state caps on punitive damages could slash that portion of the award to less than $2 million, says Victor E. Schwartz, a partner at Shook Hardy & Bacon and an expert on tort law. In addition, lawyers say Merck may have good grounds to appeal the verdict. Among the key issues: whether testimony of the coroner who performed the autopsy on Ernst was appropriate. Schwartz says a decision from the Texas Supreme Court several years ago requires judges to act as gatekeepers of the scientific evidence they allow into their courtroom. Frazier says the fact that the coroner testified that she believed there had been a clot despite an autopsy report which found no evidence of it made her opinion "unreliable scientific testimony."

The huge number of suits that Merck could eventually face has many wondering whether it will seek a global settlement. But such a settlement could be just as risky as Merck's strategy of taking on plaintiffs one by one. Consider the case of Wyeth and its liability from its diet drugs Pondimin (the "fen" in the fen-phen combo) and Redux. Wyeth agreed to settle claims in 2000, three years after pulling the drugs, which were linked to heart-valve damage. But of the 6 million people who took the drugs, many who sustained the most serious injuries passed on the settlement and sued anyway. And the settlement fund was overwhelmed by more claims than expected. So far, Wyeth, based in Madison, N.J., has taken $21 billion in reserves. Wyeth, says Columbia University Law School Professor John C. Coffee, "probably rues their decision to enter into a settlement."

Merck isn't about to disappear anytime soon, of course. "I think they'll be able to buy their way out of this for $50 billion," says W. Mark Lanier, the attorney who represented Robert Ernst's widow. But whatever the ultimate figure, it's clear that Merck will be paying for Vioxx for a long time to come.

By Amy Barrett in Philadelphia


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