Presto: A New Vioxx Liability Estimate!

Why analysts' reports shift wildly with every twist in litigation against Merck

Fifty billion dollars is a pretty eye-catching number. So it got plenty of notice in August when stock analyst David Moskowitz issued a report saying that's what Merck & Co. (MRK ) ultimately may have to pay in the thousands of Vioxx personal-injury lawsuits it faces. A Texas jury had just handed the drugmaker a stinging defeat in the first lawsuit to go to trial involving the now-withdrawn blockbuster painkiller. Merck faced up to $26 million in liability for that case alone.

On Nov. 3 in New Jersey, Merck prevailed in its second Vioxx trial, and Moskowitz, with Friedman, Billings, Ramsey Group Inc. in Arlington, Va., issued his next report. Merck's Vioxx-related exposure, he now estimated, was about $12 billion, "down from our previous $18 billion estimate."

Readers of Moskowitz's reports could be forgiven for wondering: "What $18 billion estimate?" While the original $50 billion figure, quickly picked up and propagated in the media, got two mentions in Moskowitz's August report, the $18 billion number is nowhere to be found. In an interview with BusinessWeek, Moskowitz said the $18 billion estimate was "implicit" in his August report's target stock price for Merck of $25. He called the $50 billion "a high-end" figure, based on his view that Merck's liability "could fathomably" reach that level. But, he insists, "it was never our estimate."

Pity the investor trying to make sense of this. But perhaps reserve a dollop of sympathy for analysts like Moskowitz. They thought they'd be using their expertise in fields such as finance and pharmaceuticals to evaluate stocks -- but now must try to factor in the arcane machinations of complex litigation. They have no choice. In recent years, Altria (MO ), Ford Motor (F ), Firestone, Halliburton (HAL ), Microsoft (MSFT ), and Research In Motion (RIMM ) have all faced bet-the-company litigation that Wall Street can hardly afford to ignore.

Vioxx is just the latest in a parade of mass torts to march through the pharma sector. Merck voluntarily pulled the drug from the market on Sept. 30, 2004, after one of its clinical trials suggested that it could increase the risk of heart attack and stroke for certain people. On Nov. 29, the third trial involving the painkiller is set to get under way in federal court in Houston. Close to 7,000 Vioxx suits are on the docket and more are sure to follow.


The specter of Merck facing such massive potential liability sent many drug-industry watchers scrambling to project the potential tab. As quantitative beings, analysts are hard-wired to look for "metrics" that they can plug into economic models and have a vision of the future pop out. They are used to projecting a company's future earnings, for instance, by assembling reams of data on its revenues, costs, and taxes. With litigation, they try the same approach, crunching variables such as the number of possible claimants and the likely size of a typical settlement or court award to produce sophisticated-looking reports packed with calculations and charts.

But a close look at these estimates reveals that they are often based on numbers that are flawed, simplistic, or random to the point of absurdity. Analysts also seem prone to making dramatic adjustments to their calculations based on incremental or inconsequential developments -- such as the results of a single trial. And no spreadsheet can capture the myriad intangibles that are so critical to the outcome of litigation, such as the evidentiary rulings of a judge, the deliberations of a jury, or the strategies and resolve of the opposing parties. That's a big reason why the estimates in the past year have variously projected Merck's liability at $5 billion, $10 billion, $12 billion, $18 billion, and $30 billion, not to mention Moskowitz's chart-topper.

Two reports issued by Credit Suisse First Boston (CSR ) analyst Catherine J. Arnold in February illustrate how arbitrary and accordion-like investment houses' approaches to litigation analysis can be. On Feb. 15, Arnold wrote that Merck's pretax Vioxx liability "could approximate $19 billion," a number based on 96,000 claimants winning settlements or court awards averaging $200,000. One week later, Arnold slashed her estimate to $4.75 billion. Her reason: a vote by a U.S. Food & Drug Administration advisory panel that supported Vioxx's return to the market. (The FDA has yet to act on the recommendations, and Vioxx remains off the market.)


While the 17-15 vote was a narrow victory for Merck, the panel also suggested that the FDA consider limiting the direct-to-consumer advertising of Vioxx, that it be prescribed to a restricted patient population and only at lower doses, and that it carry a so-called black box warning -- a prominent billboarding of potential hazards. The panel also agreed unanimously that data showed Vioxx significantly increased cardiovascular risk.

Sanford C. Bernstein & Co. (AC ) analyst Richard T. Evans concluded that the panel's actions left Merck's legal exposure unchanged, and, if anything, might help plaintiffs prove their case. But Credit Suisse analyst Arnold decided that the advisory body's deliberations highlighted evidence that would favor Merck and discourage litigants. She thus changed her estimated percentage of potential claimants who would actually file suit from 100% to 25%. Most recently, Arnold has raised that number back up to 50%, resulting in her latest liability projection of about $10 billion.

In an interview, Arnold acknowledges that the huge swings in her numbers might raise some eyebrows. "From a distance, it does seem peculiar to see these estimates go from one place to another." But, she adds, "we're in the early days of a very fluid situation and we're trying our best to put boundaries around it."

And both she and Moskowitz say they have no choice about trying to come up with estimates. "I don't think our job allows us the option of saying 'I don't know,"' Arnold says. But not everyone sees it that way. Deutsche Bank Securities Inc.'s (DB ) Barbara Ryan, who has covered pharma stocks since 1982, says she has refused to offer an estimate for Merck's exposure because "it's a futile exercise." If you look at past estimates for litigation involving other products, she says, "they've all been off the mark."

By Michael Orey

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