FOSAMAX LAWSUITS

Merck: The worst is yet to come?
CNNMoney.com
Aaron Smith,  
April 6, 2006

NEW YORK - Merck was once a stock-market safe haven but it's been some time since that's been the case.

As lawsuits related to the company's withdrawn painkiller, Vioxx, piled up, Wall Street has started to question the financial stability of the nation's No. 2 drugmaker.
 
Merck faces nearly 10,000 lawsuits from plaintiffs who blame Vioxx for their heart attacks. The company, based in Whitehouse Station, N.J., has lost one court verdict and won two, with a split verdict in the most recent case.

In that case, Merck was held liable by a jury in New Jersey Wednesday evening in the heart attack of a 77-year-old man who took Vioxx, but not in one suffered by a second plaintiff. The jury awarded $4.5 million in compensatory damages and was weighing punitive damages.

Merck stock sank 3 percent on the news.

Before Wednesday's verdict, Merck stock had jumped 14 percent this year, making it one of the stronger performers in the Dow Jones industrial average. Some analysts had started to believe that the worst Vioxx news was behind the company. Now investors aren't so sure.


Lawsuits: Not such a bitter pill?
Merck pulled Vioxx off the market on Sept. 30, 2004 after a study showed that it increased the risk of heart attacks and strokes. The drug hauled in $2.5 billion in sales in 2003 for Merck.

Merck has consistently denied allegations that it misled doctors and patients and said that its drug didn't kill anyone. But David Moskowitz, an analyst for Friedman, Billings, Ramsey, projects that damages against the company could reach $50 billion. Other analysts put the tally at $20 billion to $30 billion.

Still, some analysts say that even potential damages that large are already priced into the stock. Barbara Ryan, analyst for Deutsche Bank North America, said the Vioxx problems are well-known to investors, adding the market is "currently discounting a $30 billion liability."

And Robert Hazlett, analyst for Suntrust Robinson Humphrey, said it remains far from certain whether damages will end up anywhere near that high.

"I'm sure Merck will win some cases and I'm sure Merck will lose some cases, and I'm sure the stock will be volatile as a result," said Hazlett, who estimates Merck has the resources to pay out tens of billions of dollars in damages. The company had $16.7 billion in cash and investments on its balance sheet as of the end of December.

But Vioxx isn't Merck's only problem.


Weak pipeline a bigger concern
The supply of new drugs in the company's pipeline is also a worry.

On June 23, 2006, the patent will expire on Zocor, a cholesterol medicine that's currently the company's biggest seller. Zocor sales totaled $4.4 billion in 2005, making up about 20 percent of Merck's total sales.

Merck hopes to recover some of Zocor's lost sales with the cholesterol drug Vytorin, which combines Zocor with Schering-Plough's (down $0.04 to $19.00, Research) Zetia, to stop cholesterol absorption into the liver and intestine. Launched in 2004, sales for fast-growing Vytorin totaled $2.4 billion in 2005.

But the company faces other product expirations in the not-too-distant future, including Fosamax, the $3.2 billion osteoporosis drug that loses patent protection in 2008, and Cozaar, which totaled $3 billion in 2005 when grouped with anti-hypertension drug Hyzaar. Cozaar loses its patent in 2009.

Analysts are mixed as to whether Merck can fill the sales vacuum when Zocor goes generic. The company's pipeline -- drugs and vaccines in development -- has drawn mixed reviews.

Analysts tend to be bullish on Gardasil, a vaccine that has shown promise in preventing cervical cancer, with estimates ranging up to $3 billion in annual sales within five years, assuming that the Food and Drug Administration approves it.

The pipeline also includes potential blockbusters Januvia, a diabetes treatment, and a group of experimental Niacin-based drugs that could raise HDL, or "good" cholesterol.

"These are encouraging collectively, because these existing franchises and new products should lead Merck back to growth beyond 2007," said Hazlett, the analyst at Suntrust Robinson Humphrey.

But Moskowitz doesn't think the new drugs are strong enough to offset the impending losses from patent expirations. "Their pipeline is not very compelling, and the innovation we're seeing at Merck is not very compelling," he said.


Dividend at risk?
Merck's biggest problems are well-known to investors. So it's reasonable to wonder if the stock has finally bottomed out.

Les Funtleyder, analyst for Miller Tabak, said investors have grown used to dire news about Merck and haven't given the company credit for its potential blockbusters and its multi-billion dollar cost-cutting campaign. He has a price target of $40 on the stock, about 16 percent above current levels.

In addition, Merck recently raised its earnings guidance for the first quarter and all of 2006. The company will report first quarter earnings on April 20.

But Merck also said that a chief driver behind first quarter earnings was Zocor, which won't be pulling in billions of revenue past June. That's a big reason why analysts polled by Thomson First Call are projecting a 5 percent slide in sales this year and an 11 percent drop in earnings per share.

Merck still does pay a hefty dividend, yielding 4.4 percent, and that's one reason why the stock may have held up recently, Moskowitz said. But he thinks that if Merck gets hit with more bad legal news, the dividend may be at risk.

And despite the fact that Merck's stock is trading well below the level it was before it pulled Vioxx, Moskowitz said it still isn't a bargain.

Shares trade at about 15 times 2006 earnings estimates, a premium to Pfizer (Research) and just a slight discount to less-troubled drug makers like Wyeth (Research), Johnson & Johnson (Research) and GlaxoSmithKline (Research).

So while some analysts see Merck's stock price going up over the next 12 to 18 months, Moskowitz isn't so sure.

"Right now, the company has an inferior growth rate compared to the industry," he said. "When you factor in Vioxx litigation risk, it's wise to put your money in other investments in the sector."

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