Last Thursday Merck (MRK) announced that it was pulling its Vioxx drug from the market. Mr. Market was not at all happy with this development and dropped Merck’s market value by 27 percent. This was an eight year low for Merck’s market value.
Merck was proactive in informing the FDA of its research concerning the increased risk for cardiac problems associated with Vioxx. I believe Merck made the right decisions in voluntarily removing Vioxx from the market even though it will cost the company in the short term. I believe the market has over reacted to this setback, and I don’t believe the loss of Vioxx will impact the long term value of Merck. I agree with Barron’s assessment this weekend that investors have clearly overreacted. Vioxx only accounted for 11 percent of the company’s sales this year, so a 27 percent hit that Merck’s shares took is a bit excessive.
However, there is some danger that lawsuits will cut into future earnings. However, given Merck’s proactive measures and the fact that it had earlier put a warning label on Vioxx warning of cardiac risk, I think Merck will be able to manage the lawsuits. There is also the issue that Merck’s drug pipeline seems rather thin. I think the struggles that Merck has faced this year will cause the company to focus on new product development and strategic partnerships.
Looking at Merck’s free cash flow, I find that using fairly conservative estimates that Merck shares have an intrinsic value between $40 and $50. Given Merck’s 4.6 percent dividend that should be safe for quite some time, I am interested in buying Merck at this time with all of its warts and bruises. I will patiently await better days and new drug discoveries in the future while collecting a handsome dividend now.
I’m adding Merck to my Marketocracy fund Monday morning, so we can track the performance of this analysis.