Lehman Brothers Research: An Analyst Decides that the Market Overreacted to Merck's Vioxx Woes

Abstract

Very few of Tony Butler's days are predictable, but Thursday, September 30, 2004, was chaotic. Before the markets opened that day, Merck announced a voluntary withdrawal of Vioxx, one of its top earning drugs, after a new study suggested that it increased the risk of heart attacks. On Wednesday the stock had closed at $47.07. On Thursday it closed at $33.00, representing a 30% decline in market capitalization in a single day. With 2.2 billion shares outstanding, nearly $25 billion in shareholder wealth had been erased. As the managing director of Lehman Brothers' pharmaceutical equity research group, Butler was besieged by phone calls from investors asking, “Should I buy or should I sell?”

In announcing its decision to pull Vioxx, Merck argued that it had acted responsibly and done nothing wrong. However, news reports drew links to the successful class-action suits against Fen-Phen, a diet drug that had also been found to cause increased cardiovascular risk. The makers of Fen-Phen had already been forced to pay $21 billion to settle class-action suits. In the next few months, investors feverishly tried to estimate the Vioxx liability. The company had product liability insurance, but with only $650 million in coverage, Merck might be overwhelmed by litigation. Some observers even brought up the possibility of bankruptcy. By November of 2004, Merck's stock had continued to trend downward, closing as low as $26, with a loss of market capitalization of over $40 billion.

In the months following the withdrawal of Vioxx, Butler's team made its own assessment of Merck's liability. There were a number of methods for valuing both the market's assessment of the “Vioxx overhang” (the potential impact of Merck's liability) and for coming to an independent conclusion about the true net present value of Merck's liability. Butler's team's analysis consistently showed that the market had overvalued the Vioxx overhang. In the summer of 2006, almost two years after the Vioxx crisis began, Butler reflected, “When there is bad news about a company, I don't think the market ever gets it right. The market usually oversells initially, and then thinks about it much later.”

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Resources

Exhibit 1: Post-Vioxx Merck Stock Movements

Figure
Announcement detail

Announcement

Date

Share Price (close)

% Change from Prior Day

Merck voluntary worldwide withdrawal of Vioxx

Sept. 30, 2004

33.00

−26.78%

SEC and DOJ notice of formal investigation

Jan. 28, 2005

28.02

−10.13%

FDA votes in support of marketing Vioxx

Feb. 18, 2005

32.61

13.03%

Ernst (TX)—verdict against Merck

Aug. 19, 2005

28.06

−7.73%

Humeston (NJ)—verdict in favor of Merck

Nov. 03, 2005

29.48

3.77%

Plunkett (LA, Federal Jurisdiction)—verdict in favor of Merck

Feb. 17, 2006

36.05

0.19%

Cona/ McDarby (NJ)—mixed verdict

Apr. 05, 2006

35.99

1.44%

McDarby (NJ)—follow-on punitive damages verdict

Apr. 11, 2006

34.06

−1.05%

Garza (TX) re-trial—verdict against Merck

Apr. 21, 2006

34.74

−0.74%

Doherty (NJ)—verdict in favor of Merck

July 13, 2006

36.94

1.21%

Grossberg (CA)—verdict in favor of Merck

Aug. 2, 2006

41.03

0.56%

Exhibit 2: Pre-Withdrawal Estimates of Vioxx and Aroxica Sales and Contribution

Region

Phase

Prob. to mkt

Launch date

Patent expire

Peak Sales Year

2003a

2004a

Sales 2005e

($m) 2006e

2007e

Peak

Post Tax Mgn

NPV Total ($m)

NPV / Share ($)

% of EV

Vioxx

US(1)

Mktd

100%

May99

2013

2002

1,535

1,408

1,056

739

591

1,700

35%

4,079

1.8

4%

ex-US

Mktd

100%

Feb-99

2013

2004

1,014

1,181

886

531

478

1,149

30%

2,956

1.3

3%

Arcoxia

US(2)

Filed

70%

2004

2010

75

1,200

2,200

2,700

3,750

35%

4,989

2.2

5%

ex-US(3)

Mktd

100%

2002

2010

70

227

350

500

900

1,500

30%

4,403

2.0

4%

(1) Won patent dispute on COX-2 inhibitors with Searle. Optimal efficacy at 1xd 25 mg. Fewer gastric side-effects than standard NSAIDs. True once-daily, may be better. Alzheimer's is secondary indication beyond arthritis, either Vioxx or a follow-up product. 1st generic challenge June 03. Filed for migraine 2Q03 (60% relieved at 2h on Vioxx). 4Q03 filed for juvenile RA—equal efficacy to naproxen, fewer GI effects. 6m pediatric granted Feb. 04.

(2) Follow up to Vioxx. RA, OA, acute/chronic pain, dysmenorrhea, acute gouty arthritis, ankylosing spondylitis. Valued on an incremental sales basis. Filed Oct. 01. Pulled file March 02 as FDA required additional safety data in Apr. 02 vs. non-naproxen comparators. 6000 patients fully enrolled for the EDGE study. Large CV trial >20,000 patients (vs diclofenac) currently enrolling. Refiled 30 Dec. 03 with EDGE data and additional safety data as requested by the FDA, speaker at R&D meeting would not be drawn as to whether MEDAL data would be needed or when this could be provided if required. No interaction with cardiac protection of aspirin as very specific COX-2 inhibition.

(3) Launched UK, filed under mutual recognition in Europe. Nov. 03 positive EU opinion. Approved in 38 countries in Europe, Latin America, and Asia (Jan. 04).

Source: Lehman Brothers

Exhibit 3: Lehman Brothers Market Cap to Sales Ratio Analysis

Date

Market Cap ($Billion)

Market Cap to Sales

Sales ($Billion)

3/31/2000

135.307

2.84

$47.715 Actual FY 2001

6/30/2000

166.782

3.50

9/30/2000

161.879

3.39

12/31/2000

204.481

4.29

Average

167.112

3.50

3/31/2001

165.042

3.19

$51.790 Actual FY 2002

6/30/2001

138.217

2.67

9/30/2001

143.401

2.77

12/31/2001

126.481

2.44

Average

143.285

2.77

3/31/2002

123.633

5.50

$22.486 Actual FY 2003

6/30/2002

108.102

4.81

9/30/2002

97.180

4.32

12/31/2002

120.284

5.35

Average

112.300

4.99

3/31/2003

116.299

5.20

$22.382 Actual FY 2004

6/30/2003

128.393

5.74

9/30/2003

112.978

5.05

12/31/2003

102.645

4.59

Average

115.079

5.14

Pre-Vioxx Withdrawal

$25.517 Pre-Vioxx 2005 estimate

3/31/2004

98.215

3.85

6/30/2004

105.455

4.13

9/29/2004

99.664

3.91

Average

101.111

3.96

Post-Vioxx Withdrawal

$22.146 Post-Vioxx 2005 estimate

9/30/2004

73.217

3.31

11/3/2004

56.461

2.55

Pre-Vioxx Market Cap to Sales Ratio

3.91

Post-Vioxx Market Cap to Sales Ratio

-2.55

Difference in Ratios

1.36

Source: Tony Butler, “Vioxx Liability II: Lehman Brothers Equity Research Report.” November 5, 2004

Exhibit 4: Price to Earnings Ratio Analysis

Company

8/8/2006 Closing Stock Price

Number of Outstanding Shares (billions)

Market Cap ($ Billions)

Price to Earnings Ratio

Price to Earnings to Growth Ratio

2007 EPS Estimates

Bristol-Myers Squibb

20.24

1.97

39.80

17.70

3.40

1.25

Johnson & Johnson

63.47

2.96

187.94

17.20

1.72

4.02

Eli Lilly & Co

54.36

1.08

58.96

17.50

1.75

3.39

Pfizer

25.82

7.28

188.02

13.10

4.37

2.13

Abbott Laboratories

47.41

1.53

72.36

18.90

1.89

2.80

Wyeth

47.45

1.35

63.85

15.60

1.73

3.40

Mean

16.67

2.48

2.83

Median

17.35

1.82

3.10

Industry

19.83

2.19

Sector

19.37

1.77

S+P 500

14.68

1.37

Merck

40.60

2.18

88.61

16.90

3.07

2.44

Source: Yahoo! Finance. Data as of Friday August 11, 2006, market closing

Exhibit 5: Recent Pharmaceutical Litigation

Examples of Drugs Withdrawn from Market and Litigation History

Brand Name Generic Name

Propulsid Cisapride

Rezulin Troglitazone

Trovan Trovafloxacin

Baycol Cenvastatin

Fen-Phen Fenfluramine/Phenfluramine

Date Withdrawn Initiator of withdrawal

14-Jul-00 Voluntary

Mar-00 FDA driven

9-Jun-99 (restricted)

Aug-01 Voluntary

15-Sep-97 FDA driven

Reason for withdrawal

Cardiac arrythmia

Liver injury

Liver injury

Rhabdomyolosis

PPH / Valvular Disorder

Patients who took drug

unknown

2 million

2.5 million

N/A

5.8 million

Deaths, if known

410

N/A

N/A

At least 100

N/A

Class action risk?

Denied

Statewide but many denied

Unknown

Denied, isolated statewide

National Class Action

Approximate number of cases

433 cases, 5,850 plaintiffs

N/A

100 cases of liver failure

9,948 cases as of March 2004

63,000 opt-outs

Settlements

Rankin Case: 155 plaintiffs, $48 million

$975 million, less than 35,000 plaintiffs

Unknown

Through March 2004, 2,224 cases totalling $842 million. Insurance coverage to $1.2 billion.

$16.2 billion set aside for class action AND opt- out cases thus far. $3 billion paid to reserve

Source: Company Reports, Lehman Brothers Research

Litigation Background
Propulsid (Cisapride)

Propulsid, a pro-motility drug for acid reflux, was withdrawn by Janssen, a subsidiary of Johnson and Johnson, from general sale and restricted to limited use in 2000. There are approximately 433 such cases currently pending, including the claims of approximately 5,850 plaintiffs. In the active cases, 410 individuals are alleged to have died from the use of Propulsid. The lawsuits accuse Janssen and Johnson and Johnson of inadequately testing for and warning about the drug's side effects, of promoting it for off-label use and of over promotion.

In September 2001, the first ten plaintiffs in the Rankin case, which comprises the claims of 155 Propulsid plaintiffs went to trial in state court in Claiborne County, Mississippi. The jury returned compensatory damage verdicts for each plaintiff in the amount of $10 million, for a total of $100 million. The trial judge thereafter dismissed the claims of punitive damages. On March 4, 2002, the trial judge reduced these verdicts to a total of $48 million, and denied the motions of Janssen and the JNJ for a new trial.

In April 2002, a state court judge in New Jersey denied plaintiffs' motion to certify a national class of Propulsid users for purposes of medical monitoring and refund of the costs of purchasing PROPULSID. An effort to appeal that ruling has also been denied. In June 2002 the federal judge presiding over the Propulsid Multi-District Litigation (MDL) in New Orleans, Louisiana similarly denied plaintiffs' motion there to certify a national class of Propulsid users. Plaintiffs in the Multi-District Litigation have said they are preserving their right to appeal that ruling.

On February 5, 2004, Janssen announced that it had reached an agreement in principle with the Plaintiffs Steering Committee (PSC), of the Propulsid MDL, to resolve federal lawsuits related to Propulsid.

There are approximately 4,000 individuals included in the Federal MDL of whom approximately 300 are alleged to have died from use of the drug. The agreement becomes effective once 85 percent of the death claims, and 75 percent of the remainder, agree to the terms of the settlement.

In addition, 12,000 individuals who have not filed lawsuits, but whose claims are the subject of tolling agreements suspending the running of the statutes of limitations against those claims, must also agree to participate in the settlement before it will become effective. Those agreeing to participate in the settlement will submit medical records to an independent panel of physicians who will determine whether the claimed injuries were caused by Propulsid and otherwise meet the standards for compensation.

If those standards are met, a court-appointed special master will determine compensatory damages. Janssen will pay as compensation a minimum of $69.5 million and a maximum of $90 million, depending upon the number of plaintiffs who enroll in the program. Janssen will also establish an administrative fund not to exceed $15 million, and will pay legal fees to the PSC up to $22.5 million, subject to court approval.

On January 24, 2000, the U.S. prescribing information for Propulsid (cisapride) tablets and suspension, a medication for the treatment of symptoms of nighttime heartburn in adults with gastroesophageal reflux disease (GERD), was revised to include more comprehensive directions to ensure appropriate use. The primary revisions to the prescribing information included a requirement for physicians to conduct certain tests to identify patients who are not appropriate candidates for PROPULSID therapy. Included also are new contraindicated medications such as the class of protease inhibitors, which are used to treat AIDS, and new contraindicated medical conditions, such as severe dehydration.

Over the past few years, Janssen has implemented labeling changes and sponsored educational programs to help assure the safe and appropriate use of Propulsid. However, the level of adverse event reporting and risks associated with the drug did not sufficiently decrease. Consequently, Janssen has decided to stop marketing the drug and make it available only through an investigational limited access program.

Rezulin (troglitazone)

The Rezulin litigation arises from a diabetes drug developed by Sankyo in Japan and by Warner-Lambert, a company which has been acquired by Pfizer. Rezulin was reported to have been prescribed to approximately two million patients.

As announced on January 22, 2004, Pfizer took a charge to fourth quarter 2003 earnings of $975 million pre-tax ($955 million after-tax), which is expected to be sufficient to cover all known Rezulin personal injury claims arising from the use of that drug. The charge was taken in connection with our reaching agreements under which the cases and claims of approximately 35,000 individuals will be settled or withdrawn.

The agreements announced in January do not resolve and the charge does not cover non-personal injury matters, including various purported class actions. In September 2002, the federal district court managing pre-trial proceedings in the Rezulin litigation denied the plaintiffs' motion to certify a nationwide class of allegedly injured Rezulin users seeking money damages and a subclass of uninjured users seeking medical monitoring and damages for alleged consumer fraud or restitution of amounts they paid for Rezulin. In denying class certification, the court stated that Rezulin was “enormously beneficial to many patients.”

Similarly, state courts in California and Texas have denied attempts at statewide class certification. As previously reported, the West Virginia Supreme Court of Appeals did reverse a lower court's decision denying the plaintiffs' motion to certify a statewide class of allegedly injured users and purchasers of Rezulin. In addition, a purported class action seeking economic damages on behalf of users of Rezulin is pending in state court in Madison County, Illinois. The Company has entered into a contingent agreement to settle the Madison County action on behalf of all Illinois users of Rezulin.

A state court in Madison County, Illinois has certified a statewide class of all users of Rezulin seeking economic damages. The Company has entered into a contingent agreement to settle this action on behalf of that class. The agreement is subject to a number of significant conditions, including notice to the class, a hearing and court approval.

The medication treated insulin resistance, which is a physiologic state in type 2 diabetes, and was effective for many patients whose diabetes had not been controlled with other medications. We believe that the FDA-approved labeling and warnings appropriately communicated the risks associated with the medication, including the risk of liver injury, which occurred in a small percentage of patients.

Rezulin was voluntarily withdrawn by Warner-Lambert in March 2000 following approval of two newer diabetes medications, which the FDA considered to have similar efficacy and fewer side effects. As of December 31, 2002, suits involving approximately 8,700 alleged users of Rezulin had been filed in various federal and state courts.

Based on the information available to Pfizer, only a very small percentage of the claimants can demonstrate any real injury caused by the medication. For example, at the time the drug was withdrawn, there were 90 cases of liver failure reported to the FDA that were possibly or probably attributable to Rezulin. There is no valid scientific basis for concluding that Rezulin had any adverse latent effect in patients.

After a request from the FDA to consider removing the drug from the market Warner-Lambert decided to discontinue marketing Rezulin on March 21, 2000. Rezulin sales were $102 million in 2000 and $625 million in 1999 and $748 million in 1998.

The package insert for Rezulin was revised in October 1997 in response to post-marketing reports of adverse liver events. The revised labeling recommended that physicians monitor liver enzymes periodically. The labeling subsequently was changed three times to increase the recommended frequency of liver enzyme monitoring and to add other information regarding indications and adverse liver events. In June 1999, the Company withdrew the indication for REZULIN as initial single agent therapy.

Trovan (trovafloxacin)

On June 9, 1999, the Company announced that, regarding the marketing of Trovan in the United States, it had agreed to restrict the indications, limit product distribution, make certain other labeling changes and communicate revised warnings to health care professionals in the United States. Trovan is a broad-spectrum antibiotic, which was seen in post-marketing reports to be associated with severe adverse liver reactions in some patients.

Since June 1999, several suits, in both Federal and state courts, and claims, on behalf of approximately 30 Trovan patients have been received by the Company alleging liver injuries due to ingestion of Trovan. Approximately half of these matters have been resolved. There are also three purported state court class actions seeking damages and injunctive relief on behalf of Trovan patients and their spouses. The cases are in early stages of discovery.

Baycol (cerivastatin)

In August 2001, Bayer voluntarily ceased marketing Baycol, the cerivastatin anticholesterol product, in response to reports of serious side effects in some patients.

In January and March 2004, Bayer signed settlement agreements with lawyers representing plaintiffs in Baycol litigation pending in Canada. The agreements together establish a procedure to settle claims of rhabdomyolysis for all Canadian residents.

In the United States, Bayer co-promoted Baycol with SmithKline Beecham Corporation. SmithKline Beecham Corporation and Bayer Corporation have signed an allocation agreement under which SmithKline Beecham has agreed to pay 5 percent of all settlements and compensatory damage judgments arising out of actions based on the sale or distribution of cerivastatin in the United States, with each party responsible for paying its own attorneys' fees.

As of March 5, 2004, 9,948 lawsuits were pending in both federal and state courts, including putative class actions. The actions in the United States have been based primarily on theories of product liability, consumer fraud, medical monitoring, predatory pricing and unjust enrichment. These lawsuits seek remedies including compensatory and punitive damages, disgorgement of funds received from the marketing and sale of cerivastatin and the establishment of a trust fund to finance the medical monitoring of former cerivastatin users.

A motion for certification of nationwide personal injury, medical monitoring and economic refund classes was denied by a court on September 17, 2003. Similarly, on December 15, 2003, the Circuit Court of Cook County, Illinois denied a motion to certify a class action. On June 16, 2002, the Oklahoma District Court of Pottawatomie County certified a class of all Oklahoma residents who took cerivastatin and sustained muscular/skeletal injuries as a result. Bayer appealed this ruling to the Oklahoma Court of Appeals, which affirmed the lower court's class certification ruling on June 20, 2003. On November 3, 2003, the Oklahoma Supreme Court denied Bayer's motion for a writ of certiorari.

Bayer expects additional lawsuits to be filed in the United States and elsewhere. Three individual U.S. cases have been tried to date, all of which resulted in a verdict in Bayer's favor.

Bayer expects the insurance coverage for cerivastatin to be approximately $1.2 billion. Due to the considerable uncertainty associated with these proceedings, it is currently not possible to estimate the potential liability and thus no provisions exceeding the expected insurance coverage and the above referenced accounting measures already taken have been made.

Without acknowledging any liability, Bayer has settled 174 cases between January 1 and March 5, 2004 in the United States (a total of 2,224 cases through that date), resulting in settlement payments of approximately $63 million ($842 million in total).

Without acknowledging any liability, Bayer has settled 650 cases as of December 31, 2002, resulting in settlement payments of approximately $100 million.

Rhabdomyolysis is a serious condition which, in its most severe form, can lead to life-threatening kidney failure. Rhabdomyolysis has been reported more frequently in patients taking cerivastatin than other statins. This was particularly true in patients taking cerivastatin in combination with gemfibrozil, another lipid-lowering medication, and in patients taking cerivastatin in the 0.8 mg dosage.

Bayer notes approximately one hundred patients who had been diagnosed with rhabdomyolysis while taking cerivastatin who have died, as well as approximately 1,600 patients assessed with non-fatal cases of rhabdomyolysis. Accordingly, Bayer voluntarily ceased marketing cerivastatin in August 2001 and do not intend to reintroduce the drug.

Fen-Phen

It has been since the third quarter of 2003 since Wyeth has taken a charge related to its Fen-Phen diet drug litigation. The reserve balance is currently $3 billion. Since a determination by Wyeth regarding its participation in the Seventh Amendment will be made by January 8, depending upon that outcome, an increase in reserves could occur in the next few months, according to Wyeth. However, the knowledge of this charge occurring is priced into the stock already. What may be uncertain is the amount of the charge. At one time, Wyeth stated that in order to address the 7th Amendment, $1.275 billion would be needed to address Matrix Level I claims and potentially over $200 million to address Level 2 claims. While these figures are not carved in stone, it does put the figure into context and this too is priced into the stock. Overall, we view the 7th Amendment as a step in the right direction for the Company as it would help bring some closure to a large part of this litigation.

Below, for reference we provide some tidbits from the conference call during third quarter earnings that relate to the litigation.

There are approximately 63,000 downstream opt-outs who have served lawsuits on WYE. Because there can be a lag between the date when the lawsuit is timely filed and when it is actually served to the Company, this number may increase (slightly).

Based on cases reviewed so far, WYE believes many of the claims of the downstream opt-outs are procedurally or medically deficient. Over 1,700 claims have been dismissed for procedural or medical deficiencies.

In New Jersey, nearly 5500 opt-out cases have been centralized in Bergen County for case management and discovery. Superior Court Judge Charles Walsh ruled earlier this year that WYE may formally challenge before trial the evidence that allegedly support the medical eligibility of these cases. In the first round of challenges, 6 out of 10 cases decided by the Court after a challenge by Wyeth were dismissed by the Court as medically ineligible. In the second round of challenges, 74 cases were challenged and of those, only six were found eligible to proceed to trial after the challenge process.

In Pennsylvania, cases involving over 14,000 downstream opt-out plaintiffs have been filed. Over the course of the summer and into this fall, several downstream opt-out trials have taken place in Philadelphia. Of the six trials that went to verdict, the juries returned verdicts in favor of Wyeth with respect to the claims of eight plaintiffs and in favor of the plaintiff with respect to seven plaintiffs. In those verdicts that were returned in favor of plaintiffs, modest damages were awarded. In addition, the claims of 36 plaintiffs were settled, 15 discontinued their cases, two claims were dismissed by the court, and five claims were adjourned to a later trial date. In the seventh Philadelphia trial, the jury recently reached the decision in the first phase of a bifurcated trial involving four plaintiffs. The jury found the four plaintiffs collectively had been damaged in the total amount of $2.1 million. The verdict dealt solely with the issue of damages. The trial will resume on October 25 to consider whether the company is liable to plaintiffs

Looking ahead, there are currently about 135 trials scheduled to take place in the next 12 months. These involve the claims of about 350 plaintiffs. However, note that the trial calendar is a “moving target.”

On the issue of PPH cases, our Notice of Appeal in the Beaumont case was filed in August. The appeal process in this case is expected to take one to two years at a minimum. WYE continues to settle other PPH cases, where feasible.

The Seventh Amendment to the national settlement agreement received preliminary approval on August 26. Subsequently, the notice was sent to all class members who had previously registered. The deadline for class members to opt out of the Seventh Amendment is November 9. Wyeth is awaiting their responses and will determine whether or not to go forward before January 8, the official walk-away date. Wyeth can withdraw from the agreement based upon the level of participation by class members or for any other reason. If Wyeth decides to go forward with the Seventh Amendment, the fairness hearing is scheduled to take place January 18.

Thus, although the Company will continue to battle Fen-Phen litigation for some time, thus far, they have proven to be a very aggressive defender in the courtroom, having thwarted many possible plaintiff victories.

Source: Tony Butler, “Vioxx Liability II: Lehman Brothers Equity Research Report.” November 5, 2004

Exhibit 6: Lehman Brothers Merck Price Targets

Source: Lehman Brothers

Figure

Exhibit 7: Wall Street Analysts on Merck's Legal Liability

Liability Estimate

Analyst Firm

Base

Range

Date

Method/Parameters

Bear Stearns 1

$10b

$3–$15b

9/9/2005

Method 1: Total number of users experiencing a CV event out of total number of users in Kaiser Permanente's managed care program.

Method 2: Estimates of chronic users and CV events out of total prescriptions written for Vioxx.

Citigroup 2

$5b

$2–$10b

4/6/2006

Total number of cases, duration of Vioxx use, number of risk factors, probability of success and payout rate.

JP Morgan 3

Not available

$6–$20b

12/13/2004

Assumptions include (1) number of patients exposed, (2) rate of CV incidents in the given population, (3) likelihood of filing a claim, (4) likelihood for success, (5) average award size of phen-fen and Rezulin.

Lehman Brothers

$10b

$1–$10b

8/11/2006

A mix of historical benchmarking and legal analysis concerning existing case precedent.

Moody's 4

<$10b

Not available

4/20/2006

Not available.

Morgan Stanley 5

$7b

$7–$16b

3/26/2006

Based on data from NDC health, APPROVE trial and average settlement amounts paid for Baycol and Fen-Phen.

Notes: (1) Source: Boris, John T. and Jashnani, Rajeev. Bear Stearns, Merck & Co. Inc.: A Keener Focus on Growth, September 9, 2005.

(2) Source: Grofik CFA, George. Citigroup, MRK: NJ Vioxx verdicts modestly negative, April 6, 2006.

Includes third-party insurer class actions, securities litigation and legal fees.

(3) Source: Shibutani MD, Chris and Cheng CFA, Annie. JP Morgan, Merck & Co. Inc.: Murky Times Ahead, December 13, 2004.

Analysis does not include: length of use of Vioxx, internation litigation and legal fees.

(4) Source: Moody's, Moody's Affirms Ratings of Merck & Co., Inc. (Senior Unsecured Debt at Aa3); Negative Outlook, via Bloomberg, April 20, 2006.

(5) Estimate is pre-tax and before any insurance coverage.

Exhibit 8: Morgan Stanley Vioxx Lawsuit Liability Model

Base Case

Worst Case

# of Vioxx users

20,000,000

20,000,0000

% chronic (1 )

24%

24%

# of chronic Vioxx users

4,800,000

4,800,000

% taking for 18 months or longer (2)

32%

32%

# of Vioxx users taking for 18 months or longer

1,536,000

1,536,000

avg length of therapy (years)

2.36

2.36

# of patient years

3,624,960

3,624,960

Event Rates per patient year assuming 2.36 yr length of therapy (3)

Death

0.13%

0.13%

Stroke

0.36%

0.36%

Acute Myocardial Infarction

0.66%

0.66%

Unstable Angina or Ischemic Attack

0.39%

0.39%

# of Events

Death

4,712

4,712

Stroke

13,050

13,050

Acute Myocardial Infarction

23,925

23,925

Unstable Angina or Ischemic Attack

14,137

14,137

Total

55,824

55,824

% not predisposed by other risk factors (4)

50%

60%

# not predisposed by other risk factors

Death

2,356

2,827

Stroke

6,525

7,830

Acute Myocardial Infarction

11,962

14,355

Unstable Angina or Ischemic Attack

7,069

8,482

Total

27,912

33,495

% Victorious in Court or Settled out of Court

Death

85%

100%

Stroke

70%

100%

Acute Myocardial Infarction

60%

100%

Unstable Angina or Ischemic Attack

55%

100%

Estimated Payout By Event Type (5)

Death

800,000

1,000,000

Stroke

550,000

650,000

Acute Myocardial Infarction

350,000

400,000

Unstable Angina or Ischemic Attack

100,000

175,000

Awards by Event Class

Death

1,602,232,320

2,827,468,800

Stroke

2,512,097,280

5,089,443,840

Acute Myocardial Infarction

2,512,097,280

5,741,936,640

Unstable Angina or Ischemic Attack

388,776,960

1,484,421,120

Total Awards (5)

7,015,203,840

15,143,270,4000

Annual legal fees

90,000,000

90,000,000

Number of years of litigation

12

15

Total Legal Fees

1,080,000,000

1,350,000,000

- Legal Reserves (as of Dec 31, 2005)

970,000,000

970,000,000

Remaining Legal Fees

110,000,000

380,000,000

Total Estimated Liability

7.1 bn

15.5 bn

Insurance Coverage (6)

0.63 bn

0.63 bn

Estimated Remaining Liability

6.5 bn

14.9 bn

Tax deduction (assuming 35% corporate rate)

−2.3 bn

−5.2 bn

Suggested after-tax liability

4.2 bn

9.7 bn

Footnotes: 1 & 2: as estimated by NCD health

3: based on data from APPROVE trial

4: placebo group in APPROVE trail showed an incidence rate of 0.75%, suggesting only half of total events can be traced to Vioxx

5: average settlement amount paid to Baycol patients and Fen-Phen matrix-level claimants has been $385,000

6: Merck disclosed that its insurance policy covers up to $630 million in legal fees and damages.

Source: Rubin, Jami and Garcia-Tunon, Carlos. “Merck & Co. Obervations from Cona/McDarby Case.” Morgan Stanley Equity Research Report. March 26, 2006.

This case was prepared for inclusion in Sage Business Cases primarily as a basis for classroom discussion or self-study, and is not meant to illustrate either effective or ineffective management styles. Nothing herein shall be deemed to be an endorsement of any kind. This case is for scholarly, educational, or personal use only within your university, and cannot be forwarded outside the university or used for other commercial purposes.

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