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27 Jan 2005
CORRECTION TO HEADLINE: MOODY'S LOWERS LONG TERM RATINGS OF MERCK & CO., INC. (SR. UNSEC. TO Aa3 FROM Aa2); CONFIRMS PRIME-1 SHORT TERM RATING; NEGATIVE OUTLOOK (NEW RATING SHOULD BE Aa3 NOT A3)
Approximately $4.9 Billion of Rated Long Term Debt Affected
New York, January 27, 2005 -- Moody's Investors Service lowered the long term ratings of Merck
& Co., Inc. (senior unsecured to Aa3 from Aa2),
concluding a rating review initiated on November 9, 2004.
At the same time, Moody's confirmed Merck's Prime-1
short term debt rating. Following these rating actions, the
rating outlook is negative.
The downgrade to Aa3 primarily reflects the concern that free cash flow
will likely erode over the next several years at a time when the company
faces uncertain but potentially very high legal exposures related to Vioxx.
The downgrade has been limited to 1 notch at this time because Moody's
currently believes it is unlikely that Merck's Vioxx-related
cash outflows will exceed $10 billion over the next three years,
and because Merck's liquidity remains strong with $14.2
billion of cash and fixed income investments (as of September 30,
2004) compared to $2.2 billion of short term debt.
New information incorporated by Moody's since the rating review
initiated on November 9, 2004 includes Merck's R&D pipeline
update on December 14, 2004, its 4th quarter earnings report,
and greater clarification of its Vioxx litigation strategy. In
addition, further controversy in the COX-II category has
ensued following adverse safety results of Pfizer's Celebrex publicized
in December, which has further dampened the prospects for Merck's
Arcoxia, in Moody's view. Based on the performance
of Merck's remaining products, its recent launches (namely
Vytorin), its pipeline opportunities, and considering the
Zocor patent expiration, Moody's anticipates free cash flow
(after capital expenditures and dividends but before any litigation payments)
of approximately $1.5 billion in both 2005 and 2006.
Moody's estimates that free cash flow will represent 15-20%
of adjusted gross debt, which includes an adjustment for unfunded
pension liabilities and the present value of operating leases.
Earlier, Merck consistently generated free cash flow in the $3
to $4 billion range, usually representing 30% or more
of adjusted gross debt. The downgrade to Aa3 reflects Merck's
declining ratio of free cash flow to debt compared with highly-related
global peers, as recently outlined in Moody's Global Pharmaceutical
Rating Methodology. Typically, Merck's Aa-rated
peers exhibit a higher ratio of free cash flow to debt, healthier
prospects from the pipeline, or much lower litigation risk.
To date, Merck has announced that 1,400 plaintiff groups have
filed Vioxx-related lawsuits against the company, but this
number could grow significantly higher as plaintiff attorneys develop
litigation strategies. In addition, Merck faces putative
class actions, securities lawsuits, and ERISA-based
lawsuits. The company has reserved $675 million related
to Vioxx legal issues, although this amount is solely to cover increased
legal expenses over the next several years, and does not include
a reserve for any payments to plaintiffs. The company has announced
that it believes it has meritorious defenses, that it acted appropriately
at all times, and that it intends to defend the lawsuits vigorously,
including taking cases to trial. Merck has also said it will oppose
any efforts to seek class-action treatment because of a lack of
commonality to the cases. Moody's generally expects that
it will be difficult to have class actions certified for the product liability
cases. However, Moody's remains concerned about the
possibility of large individual court verdicts, which may occur
if plaintiffs are successful in demonstrating that Merck's response
was not timely or that the drug was marketed in an overly aggressive manner.
The recent Vioxx-related investigations by the Department of Justice
and the Securities and Exchange Commission create further uncertainty.
At this point, Moody's believes that the normal pace of the
legal process, which can include appeals spread over several years,
and the current unwillingness of the company to settle, makes it
unlikely that any hypothetical payments would occur before two to three
years, which may leave time for Merck to further strengthen its
balance sheet if required. However, if adverse trial outcomes
change the company's strategy with respect to settling cases,
then higher cash outflows may ensue. The outcome of court cases
over the next 12 to 18 months should provide much greater insight into
these issues, particularly as we gain clarity on what the type of
evidence will be allowed admissible in the courts.
Following this rating action, the outlook on Merck's rating
is negative, and will be influenced by a combination of developments
in the Vioxx litigation and the prospects for Merck's core pharmaceutical
business, which are currently weaker than just a year ago.
In addition, the upcoming change in senior leadership expected by
2006 creates some uncertainty as to potential changes in strategic direction,
especially in light of Merck's recent share price performance.
As a result of these issues, Moody's believes that Merck's
rating may face volatility over the next few years.
Any of the following situations could cause a rating downgrade:
(1) adverse developments related to Vioxx litigation that could cause
the ultimate litigation costs to exceed $10 billion; (2) lower
likelihood of achieving annual free cash flow of $1.5 billion
(before litigation) over the medium term; (3) pipeline disappointments;
or (4) a major change in financial policies or acquisition strategy.
To meet the free cash flow estimates, Moody's believes that
the sales uptake of Vytorin would have to be very successful, exceeding
$1 billion in total 2005 sales and $2 billion in 2006 sales.
A combination of any of these potential negative developments could lead
to a multi-notch downgrade.
For the rating outlook to stabilize, Moody's would need to
become more optimistic that the overall magnitude of Vioxx litigation
costs will be modest, which may occur if very few lawsuits are filed
against Merck over the next 12 to 18 months, or if there is a low
success rate of cases actually going to trial. In addition,
a more stable rating outlook would also depend on the business outlook
including the success of Vytorin, the advancement of candidates
through the pipeline without major setbacks, and maintenance of
conservative financial policies.
Merck & Co., Inc. -- Issuer rating,
notes, medium-term notes, Euronotes, Eurobonds,
debentures, and industrial revenue bonds to Aa3 from Aa2; Shelf
rating to (P)Aa3 from (P)Aa2
Merck & Co., Inc. -- Prime-1 commercial
paper, VMIG 1 industrial revenue bonds
Headquartered in Whitehouse Station, New Jersey, USA,
Merck & Co., Inc. [NYSE: MRK] is a
worldwide research-intensive company that discovers, develops,
produces, and markets human and animal health products and services.
Merck reported net pharmaceutical sales of approximately $23 billion
Corporate Finance Group
Moody's Investors Service
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service
No Related Data.
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