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Merck's future just got murkier
In Vioxx lawsuits, it now looks like the FDA's credibility will go on trial -- and that's bad news for the drug maker.
By Jim Jubak
Merck's best defense in the cascade of lawsuits it faces from consumers who claim they were harmed by taking Vioxx is crumbling. That isn't because of any missteps by the company. No, as is so often the case in the drug industry today, the problem is the U.S. Food & Drug Administration. In the last month, the FDA has managed to put its own competence and scientific expertise on trial.
The fact that the FDA had approved Vioxx for safety and efficacy had looked to be one of the strongest parts of Merck's defense. Hey, the company could argue, after weighing the risks and the rewards, the scientific, impartial FDA decided that Vioxx belonged on the market. With that approval, how can anyone say that Merck (MRK, news, msgs) acted recklessly?
But it now looks increasingly likely that lawyers for plaintiffs will be able to portray the FDA as a toady for the drug industry. The agency's scientific credibility, not a strong point going into the trial, will take a battering.
How all this will sit with judges and juries is anybody's guess. That's not good news for investors who have held onto the stock after the company withdrew Vioxx, a best-selling COX-2 pain reliever, from the market. Or for investors who have bought the shares on a bet that the damage won't be anywhere near as bad as Wall Street fears. The uncertainty about this case is higher now than it was at the end of last year when the stock was heading for the bargain basement.
As of the end of December Merck faced, by its own count:- 575 product-liability lawsuits by 1,400 plaintiff groups;
- 70 potential product-liability class-action lawsuits;
- and 14 securities class-action lawsuits claiming that the company and its officers violated federal securities laws by issuing false and misleading statements to investors.
Wall Street estimates for the potential damage to Merck from all these suits ranges from a low of $4 billion to a high of $32 billion. At $4 billion, Merck takes a hit but survives without difficulty: The company's net income in 2004 came to $5.8 billion even after it put aside a $600 million reserve to handle its legal costs in the Vioxx cases. (Merck has not established a reserve for paying any product-liability damages.) At $32 billion, the company's survival would be in doubt.
The difference between $4 billion and $32 billion largely depends on how successfully Merck argues in court that it did all it could and followed all reasonable precautions to make sure Vioxx was safe.
FDA's credibility a huge issue
Reasonable is, of course, in the eye of the beholder. And that's where the FDA comes in. Merck is expected to argue that it followed all the rules laid out by the FDA for assuring that a drug is safe, and that since the agency approved Vioxx, Merck certainly didn't act irresponsibly or with reckless disregard for the health of those who took the drug.
Unfortunately for Merck, the FDA's credibility took a huge hit after its advisory committee voted in mid-February to keep all three COX-2 painkillers, Merck's Vioxx and Pfizer (PFE, news, msgs)'s Celebrex and Bextra, on the market. After examining studies that showed a correlation between long-term use of high doses of Vioxx and Bextra and higher incidence of heart attacks and other cardiovascular events, the committee decided that the benefits of the drugs to patients outweighed the risks -- as long as a more detailed label warned about the dangers of these drugs. (Even though these three drugs all belong to the class known as COX-2 inhibitors, the three drugs should not be lumped together. The evidence so far is contradictory, but it seems to show that Bextra and Vioxx are more highly correlated with cardiovascular events than Celebrex.)
Related news and commentary on MSN Money
Wall Street cheered. Merck's shares surged 13% on Feb. 18. A quote from Bert Hazlett, an analyst at SunTrust Robinson Humphrey, captures the first-day reaction: "I wouldn't want to be a plaintiff's lawyer right now."
But plaintiffs' lawyers did better than the headlines -- and the stock market's reaction -- indicated. The vote on Vioxx and Bextra was very close. Unlike Celebrex, which got a 31-1 vote of confidence from the advisory panel, members voted just 17-13 (with two abstentions) to keep Bextra on the market and only 17-15 in favor of Vioxx. (Merck voluntarily withdrew Vioxx from the market in September 2004.)
Panel members tied to drug companies
And even that limited vote of confidence came into question when, days later, the New York Times published a study of which scientists on the advisory panel had ties to Merck, Pfizer and Novartis (NVS, news, msgs). (Novartis does not have a COX-2 inhibiter painkiller on the market but does have one in its development pipeline.) According to a study by the Center for Science in the Public Interest requested by the Times, 10 of the 32 experts on the FDA COX-2 advisory panel evaluating these drugs had what the Center for Science in the Public Interest called "affiliations" with the drug companies. These "affiliations" included the receipt of consulting fees, research support and speaker's fees.
As the Center for Science in the Public Interest noted, "This would appear to be a direct violation of the Federal Advisory Committee Act, which prohibits scientists with direct conflicts of interest from serving on panels offering advice to federal regulatory agencies."
The credibility of the FDA -- and at least the validity of its advisory panel's recommendation on Vioxx and Bextra -- took an even bigger hit when the New York Times analyzed the vote in light of these conflicts of interest. If the 10 scientists with conflicts of interest hadn't voted, the advisory panel easily would have voted to remove Vioxx and Bextra from the market.
Just two weeks later, in testimony before the Senate Committee on Health, Education, Labor and Pensions, the FDA made Merck's legal problems worse. Sandra Kweder, deputy director of the FDA's office of new drugs, testified that Merck resisted changes to the Vioxx label that would have highlighted heart risks to patients. More than a year passed, Kweder told the committee, between the time an FDA advisory panel recommended that the cardiovascular risks of Vioxx should be emphasized on the drug's label and the actual change to the label. Kweder called that period, February 2001 to April 2002, "unusually long."
Plaintiffs have emotion on their side
So, pity the poor plaintiff's lawyer? I don't think so.
The FDA has torn a gaping hole in the ability of Merck to argue that FDA approval is all a drug company needs to show it acted responsibly. I don't know if a judge and jury will be convinced that Merck's money overwhelmed the FDA's science and bought approval for Vioxx. But I do know that if I were a lawyer for the plaintiffs, I'd certainly argue that case. It has just the kind of big company/little consumer appeal that wins big judgments.
And the FDA has handed plaintiffs' lawyers a legal roadmap. (For instance, how about calling FDA advisory panel meeting Chairman Alistair Wood of the Vanderbilt University Medical School, who said after the vote, "The data are very compelling. Vioxx is substantially worse than the others.") Think it will be hard to portray Merck as a company fighting over the Vioxx label in order to boost profits while patients, without the warning that the FDA had recommended, got sick or died?
Product-liability cases often don't have very much to do with justice and evidence. They often hinge on which side can make an emotional argument that is convincing but doesn't overwhelm the jury with endless detail. Before Merck's "victory" at the FDA in mid-February, I thought the odds were that Merck would be able to limit the damages it faced from these suits. It seemed these cases would quickly sink into a morass of scientific detail about which study showed what and when, about the mathematics of risk/benefit calculations and about the difficulties of figuring out the potential effects on real patients from studies that use extremely high dosages.
But the events at the FDA in the last month make it more likely that the plaintiffs will be able to make the kind of emotional argument that wins cases like these by sticking to the hot-button issue of a company using its money to overwhelm the safeguards that are supposed to protect the drug supply.
I still don't know if justice -- whatever that may turn out to be -- will be served. I do know that as an investor, I'm less interested in justice than in which party will win. And the odds, thanks to the FDA over the last month, have tilted against Merck.
New developments on past columns
10 best stocks for the rest of 2004
Smithfield Foods (SFD, news, msgs) is turning into one of the 10 best stocks for 2005 as well. In its March 1 earnings report, the company hit the 87 cents a share it had told Wall Street analysts to expect for the company's fiscal third quarter on Feb. 14. Earnings per share climbed 121% from the third quarter a year earlier on a 13% increase in sales. The big difference: a 48% increase in live hog prices and higher margins in its fresh pork business. Still, there is room for improvement: The beef and cattle segment showed an operating loss of $200,000 in the quarter. As of March 4, I'm raising my target price to $38 a share by June 2005 from the previous target of $33 by March. (Full disclosure: I own shares of Smithfield Foods.)
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Smithfield Foods. He does not own short positions in any stock mentioned in this column.
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