Merck & Co.: NJ Supreme Ct Ruling Provides Promising Insights M
2007-04-05 04:08 (New York)
NORTH AMERICA
April 5, 2007
(MRK.N) Merck & Co.
Merck & Co.: NJ Supreme Ct Ruling Provides Promising Insights
Jami Rubin +1 (1)212 761 4651 Morgan Stanley & Co. Incorporated
Shibani Malhotra (212) 761 6349 Morgan Stanley & Co. Incorporated
Louise A Chen Morgan Stanley & Co. Incorporated
Michael C Rockefeller Morgan Stanley & Co. Incorporated
Conclusion We have always maintained that the consumer fraud class action suits
(rather than individual cases) represent the biggest risk to Vioxx liability.
Last week's ruling by New Jersey's Supreme court in the Rowe vs. Hoffman La
Roche case gives us a peek into the thought process of the NJ Supreme Court and
provides us with clues as to how it could rule in the pending International
Engineers vs Merck case.
What's New: On March 29th, the NJ Supreme Court ruled 5:2 in favor of Roche, in
the Rowe vs. Hoffman La Roche case reversing an earlier Appellate court's
decision. Specifically, the court ruled that in this case, in which the
plaintiff (Rowe) was a Michigan resident who used Accutane (manufactured in NJ
by Roche) in Michigan for three months, Michigan's law should be applied instead
of New Jersey's law.
Implications: Based on our read of the court decision, we believe there may be
a reversal of the Superior Court of New Jersey Appellate Division's decision in
the International Engineer's vs. Merck case as well as other Vioxx cases that
went negative for MRK in Atlantic city. Here's why: 1) Laws in other states
differ from those in New Jersey and, NJ Supreme Court is unlikely to enforce its
own law in cases involving out of state plaintiffs. 2) The differences in law
makes it difficult to try the entire International Engineers vs Merck case as a
single. 3) The ways the Judges voted in the Rowe suggests the International
Engineers vs. Merck case may tilt slightly in Merck's favor (4 of 5 the judges
in the MRK case were on the Rowe case). 4) The Supreme Court will likely be
tough on upholding NJ's standards regarding punitive damages, as such, we are
optimistic that the two cases lost by Merck in Atlantic City will be
successfully appealed at the higher court level.
Stock Rating: Overweight
Industry View: In-Line
Share Price: USD 45.37 (Apr 4, 2007)
Target Price: USD 53.00
Market Cap: (mm) USD 98,564
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FULL RESEARCH TEXT BELOW:
Investment Case
Summary & Conclusions
We have always maintained that the consumer fraud class action suits (rather
than individual cases) represent the biggest risk to the size of the Vioxx
liability. Last week's ruling by New Jersey's Supreme court in the 'Rowe vs.
Hoffman La Roche case gives us a peek into the thought process of the NJ supreme
court and provides us with clues as to how it could rule in the pending
International Engineer's vs Merck case, as well as the appeal's process from the
two Atlantic City Vioxx losses, McDarby and Humeston.
Last week the New Jersey Supreme court ruled 5:2 in favor of Roche, in the Rowe
vs. Hoffman La Roche case reversing an earlier Appellate court's decision.
Specifically, the court ruled that in this case, in which the plaintiff (Rowe)
was a Michigan resident who had lived his entire life in Michigan and used
Accutane (manufactured in NJ by Roche) in Michigan for three months, Michigan's
law should be applied instead of New Jersey's law. Michigan State law says that
FDA approval means that the health risk warnings were adequate whereas NJ state
law says that FDA approval only creates a rebuttable presumption of adequacy.
The Supreme Court of New Jersey applied a two-step analysis in determining that
it was appropriate for Michigan law to apply. In the first step, it determined
that there was a conflict between Michigan law and New Jersey law. In the second
step, the court determined that NJ's interest in the case (ensuring that
corporations were deterred from producing unsafe products and providing
inadequate
warnings) was limited and outweighed by Michigan's interest (making
prescription drugs generally available to its citizens).
While we understand this was a "conflict of laws" case dealing with 'which
state's law should be applied' and not 'can a life long resident of Michigan sue
a New Jersey Corporation in N.J.', we believe that this case provides us with
some insights that can be applied to the International Engineer's vs. Merck case
as well as other Vioxx cases.
Laws in other states differ from those in New Jersey and, NJ Supreme Court is
unlikely to enforce its own law in cases involving out of state plaintiffs
This case highlights that where there are sufficient differences in consumer
protection statutes across states (our legal consultant believes these
differences are material in many cases), it is unlikely that the NJ Supreme
Court will simply sweep these differences under the rug, and apply its own law
to CPA claims in suits brought by out of state plaintiffs.
The differences in law makes it difficult to try the entire International
Engineers vs Merck case as a single one
The plaintiffs in this case are third-party payers from 50 different states who
are seeking to recover Vioxx purchase costs (plus other damages) as they believe
they would have paid less for the drug had they known of its alleged risks. Our
legal consultant believes based on the oral argument in this case, it may be
that to deal with this issue, the Supreme Court of New Jersey could decertify
the nationwide class, but uphold a New Jersey plaintiff-only class (which would
then be a smaller case).
The Supreme Court will likely be tough on upholding NJ's standards regarding
punitive damages, which would be positive for Merck
According to our legal consultant, there may be a 'hidden gem' for MRK in this
decision, which is how the Court views its own law with respect to liability and
compensatory damages. New Jersey law "conclusively prohibits an award of
punitive damages in product liability actions". In this case, while the dissent
points out that there is an exception to the punitive damages immunity the
Majority clearly seems to understand the strength of the statute's shield
against punitive damages. We do not believe that Judge Higbee gave this type of
deference to the NJ statute and, as such, we are optimistic in our view that the
two cases lost by Merck in Atlantic City will be successfully appealed at the
higher court level.
Voting in the Rowe case suggests the International Engineers vs. Merck case may
tilt slightly in Merck's favor
Of the five NJ Justices that ruled in favor of Roche (in the Rowe case), four
are sitting on the International Engineers vs. Merck case too (there are five
justices in the Merck case). Our analysis suggests that of these Judge Long is
the one most likely to rule against Merck, and a potential likely outcome could
be 3:2 split in favor of Merck. We expect a decision on MRK's appeal of the
nationwide class action suit over the next six months.
We arrive at our target price based on a blended valuation approach using both
P/E multiples and residual income driven by ROIC, which we believe is more
useful than a pure P/E approach since MRK's earnings will not begin to
meaningfully accelerate until 2008-10. Our price target assumes a target P/E of
20x our 2008 EPS estimates, which reflects a premium valuation owing to MRK's
accelerating growth story well above the industry average. In addition, our
target assumes a $3/share NPV hit for future Vioxx payments of $15 billion.
Risks to our target include R&D setbacks and higher than expected Vioxx
payments.
COMPANY DESCRIPTION:
Merck is a global pharmaceutical products and services company that discovers,
develops, makes and markets a broad range of products to improve human and
animal health, directly and through its joint ventures. The company's products
include cholesterol drugs Zocor and Zetia and hypertension drug Cozaar/Hyzaar.
INDUSTRY VIEW: In-Line
GICS SECTOR: Health Care
Strategist's Recommended Weight: 12.9%
S&P 500 Weight: 11.9%
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