02/27/2003

When American Home Products recalled its diet drug Fen-Phen in 1997, it did not expect to pay heavy compensation for the alleged side-effects.

Yet, since losing a Texas court case two years later, the US pharmaceuticals group has had to set aside more than Dollars 13bn to cover legal liabilities and has seen three attempted mergers collapse.

The same fate could now be facing Bayer, the German conglomerate, which was forced to pull its cholesterol-lowering treatment from the market in 2001 after the drug was linked to a muscle-weakening disease and a number of deaths.

Bayer is also involved in a Texas court case, where the plaintiffs' lawyers are trying to prove that management were aware of the risks of the drug - called Baycol in the US and Lipobay elsewhere - well before the regulators forced it to be recalled.

That was the argument that turned the Fen-Phen case into a multi-billion dollar liability for AHP.

Meanwhile, Bayer had been attempting to solve the disarray in its pharmaceuticals division by merging the business with that of a rival. Faced with such legal uncertainty, however, an attractive deal for Bayer's drugs business will be even harder to achieve.

The litigation fears have sent Bayer shares into freefall.

After tumbling more than 14 per cent on Tuesday, they dropped a further 8 per cent in late trading yesterday when Werner Wenning, Bayer chairman, admitted for the first time that the group might have to make provisions for Baycol liabilities.

"It is impossible to predict the outcome of any litigation, particularly in the US," he said. "We will address the question of provisions appropriately in the future."

Baycol has returned to haunt Bayer because of the start of the first trial about the drug, in Corpus Christi, Texas.

The plaintiffs' lawyers have submitted memos and e-mails which they claim show Bayer executives knew of the drug's side-effects.

As well as the litigation, investors have been concerned that Bayer could lose its product insurance for Baycol - believed to be worth more than Dollars 1bn - if it is shown to have withheld information.

"We continue to believe firmly that the company acted responsibly, properly and appropriately in the case of Baycol," Mr Wenning said yesterday.

With so little concrete information, the result has been feverish speculation about the potential liability, with some estimates going as high as Dollars 10bn.

"The market reaction has not been justified," says Andreas Theisen at West LB Panmure in Frankfurt. "However, nobody is able to quantify the potential impact."

Since the recall of Baycol, which was Bayer's most promising drug, the group has embarked on a search for a partner for its pharmaceuticals business - something investors had been urging for years.

Last year, Mr Wenning outlined the structure of a "new Bayer", essentially a holding company with four separate legal entities: healthcare, agrochemicals, chemicals and polymers. Although he denied the group was preparing the ailing healthcare unit for sale, he raised hopes it would adopt a pragmatic approach to the division's future, which in the 1980s was one of the industry leaders but which is now barely among the top 20 companies.

Even before the litigation fears mounted, Bayer had been finding it difficult to find a partner. It has already sold the marketing rights for its most exciting new product - erectile dysfunction treatment Levitra - to GlaxoSmithKline.

Moreover, Bayer has insisted that it wanted to remain a majority partner in any merged unit - and few drugs businesses with good prospects would want to play second fiddle to Bayer.

According to Mr Theisen, Bayer senior management does not have the time to negotiate a deal at the moment.

"I don't expect them to come up with a partner any time soon," he says.

"The Baycol affair may turn into a matter of life and death for Bayer," adds one person familiar with the company. "Maybe this will also show that the idea of a holding with four business units has outlived itself."