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Lehman Brothers Research

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Yale School of Management
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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."

Published Date: 27/09/2006

Suggested Citation: Spencer Hutchins, " Lehman Brothers Research," Yale SOM Case 06-014, September 27, 2006

Keywords: Pharmaceutical