Cases filed on Vioxx surge. Lets do the math.

In one of the better articles I've read on the business and shareholder issues facing Merck as a result of their Vioxx litigation is available on MSN Money by clicking here. It's a must read to get a handle on the relative costs and potential value of cases facing Merck as a result of it's Vioxx cases.

The online Wall Street Journal, which requires a subscription, has a good summary here as well.

Essentially they are reporting that there has been the expect last minute surge in cases filed on Vioxx claims, as the 2 year statute of limitations is set to expire on October 1, 2006 in many states, which relates to the date two years ago that Merck pulled the drug off the market when it's cardiac risks became more widely known. 

Being primarily a numbers guy who comes from a finance and management back ground I have always been intrigued at the close to $1 billion Merck had set aside for legal defense on this litigation, which according to this article, they have spent $285 million so far on the 10 trials to date. That ladies and gentleman, is one huge number, that works out to $28.5 million per trial. Now obviously, much of that money has been spent on general research, defense costs, witnesses, etc that are one time expenses that will be eventually amortized across many trials, so the pure cost for trial is far south of the $28.5 million figure. Attorney Chris Seeger is quoted as estimating Merck's defense cost per trial at $15 million, which is still a breath taking figure, but far below $28.5 million.

And we wonder why the defense attorney's are so excited about a "try each case one at a time" strategy. I always chuckle when people talk about what plaintiff attorney's make, when the amounts spent on most defense work is far more then the vast majority of plaintiff fees, with zero attendant risk as they are being paid hourly by either insurance companies or corporate defendants to defend the case. Let me be clear, I have zero issue with them getting  paid and Merck has some great lawyers arguing their case, and I say more power to them. It's America, and you can do what you want. However, just don't talk about what trial lawyers stand to make on these cases when this litigation is going to buy a lot of property in the Hamptons for a lot of big defense firm partners.

Anyways, lets do a little fun math and think about what Merck's shareholders, the real elephant in the parlor on this litigation, should be concerned with.

First, lets assume that as reported in the article there will end up being something close to 30,000 cases either filed or pending with statute of limitations waived per agreement. That's a nice conservative number and reflects what is reported in NJ and New Orleans courts.

Next, lets assume that due to Merck's aggressive defense posture that a lot of junk claims haven't been tossed into the pool as has happened in many other mass torts. I personally know that the mass tort bar is very skittish about filing bad or questionable claims after the recent blow up in Texas on the asbestos and silicosis cases, so i'd estimate that maybe 10% of the pending 30,000 might be dismissed on various grounds. I think that might be a high number, but lets use if for illustration here. That moves our baseline of cases to 27,000.

We now have two direct costs for Merck to calculate going forward, and one huge indirect cost. The two direct costs are the cost of defense per case and the cost of awarded damages on cases tried to conclusion. ( Assuming that Merck continues it's defend them one at a time strategy forever.) Lets calculate the direct costs first.

Cost of defense is currently $15 million per case. This average cost will continue to drop as more cases are filed and the investment in their defense is amortized, however, even if the cost were to drop to a fraction of $15 milion, to lets say, $750,000 per trial in today's numbers, if you assume they need to defend 27,000 cases you have a direct cost of defense of $20.25 BILLION dollars. Yes, 20 billion in defense costs in an absolute best case scenario for Merck. It could very easily exceed that number if they proceed forward with the "defend them one at a time" strategy but i'm being exceptionally generous in this estimate based on the current hard numbers we have to date..

Ok, the next cost is going to be the average award per case. Lets assume that Merck continues to win 50% of all cases taken to trial, a very generous assumption given that history indicates that as litigation drags on, more evidence comes out, plaintiffs get better at selecting cases and trying them, and ultimately being successful in court. Still, that would bring the total potential number of verdicts to 13,500. Not a huge number, right? However, lets look at what the average award and verdicts have been so far. The net awards have been $26 million, $13.5 million, $7.75 million and $51 million. The last amount is going to be reduced per Judge Fallon's ruling and a new damage trial is scheduled. Lets go way low and assume the plaintiff gets $3 million. This brings the average award per plaintiff verdict to $12.56 million per plaintiff verdict. Now, as a settlement guy I would say that is way high as a base line on a block of cases the size of 13,500, so again, lets assume everything goes Merck's way and figure the average trial verdict settles in about $7 million, or approximately half what evidence currently shows now. So, doing the math, the potential verdict risk to Merck in a best case scenario is right about $95 BILLION.

Lets add the numbers doing a little rounding to simplify the illustration. $20 billion for legal defense costs. $95 billion for  verdict risk. That's $115 billion in an absolute best case scenario for Merck under their current mode of operation. $115 billion. Also note the cost of defense alone is twice the value of some of the largest verdicts in US history on product liability mass torts.

The third cost is the huge drain on management time, energy, attention and resources. Defending a defective product for a decade isn't a productive use of management time and resources. What's the price of distraction? Again, lets be exceptionally generous and assume it's about $2 billion over several years, although many might argue it's far, far higher given the cost to the companies reputation, marketing efforts, relationships with doctors, medical schools and medical journals given the facts as they continue to come out.

So, we have a cost figure of $117 billion at this stage. That figure, in today's dollars, represents 125% of the present market capitalization of Merck, which is approximately $92 billion at the time i'm doing these calculations. This, on a best case scenario for Merck under their current litigation path and philosophy. Now, some of this cost is going to be absorbed by liability carriers, but most of it is going to rest with Merck, so lets discount insurance reimbursement for now.

I feel that most institutional investors have grossly underestimated the cost of litigation on this drug, and once the numbers start to come in they are going to wonder how it is that Merck's management embarked on this potentially disastrous strategy of trying every case. I've said from the beginning on this litigation if Merck offers to settle these cases for an average of $3.5 million per case, and set up a special master to administer the claims, and figure that half the cases might be tossed by a committee, you'd be looking at a case valued at the very most at approximately $20 billion in total costs to shareholders, plus a sane, objective method of sorting through cases that didn't involve Merck's management in a decade long battle and drain of resources, reputations and talents. Instead we have this litigation freight train blasting along the tracks with costs and risk for all parties expanding as each month passes.

Merck shareholders need to do the math at some point. Best case scenario of $115 billion according to Mark's Math. Worst case? Double it. Or settle into a 468B trust with a special master and get on with producing safer and more effective drugs and repair the damage the Vioxx case has caused. It's inevitable but as long as defense interests have an open check book and a claim on company resources, this insane strategy will continue to balloon the ultimate cost.

* The Online WSJ Saturday edition ran a commentary on Merck in it's Breaking Views section that essentially raises many of the points i've made. Good stuff for those of you who have access to it by clicking here.  

Posted on September 30, 2006 .