Are GSK’s legal troubles a threat to the firm’s survival?

Over the past week, GSK (LSE: GSK) shares have fallen off a cliff. The FTSE 100 company has seen its market value plunge 17% and recent spin-off Haleon (LSE: HLN) has followed suit, plunging 14%.

We don’t have to look far to understand why investors have been running for the hills. It all comes back to a drug called Zantac, an over-the-counter heartburn drug that was pulled from sale in 2019.

A legacy drug comes back to haunt GSK

GSK launched Zantac in 1981 as a prescription medication and it went on to become an over-the-counter treatment in the mid-90s. Now there’s a bit of a corporate paper trail to get through here to explain what happened next.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

The drug was developed in a joint venture with a company called Warner Lambert. Warner bought out its partner, GSK in 1998, but was then acquired by Pfizer (NYSE: PFE). Pfizer sold its over-the-counter business (including Zantac) to Boehringer, which then sold this business on to French pharmaceutical giant Sanofi.

As a result, all of these pharmaceutical companies have some exposure to the drug, and, therefore, they have exposure to a growing volume of lawsuits that argue the drug causes cancer. Litigants also argue that Sanofi, Pfizer and GSK all didn’t do enough to warn customers of the risks of taking Zantac.

Haleon, which is an amalgamation of both GSK’s and Pfizer’s over-the-counter and consumer healthcare businesses, is the most exposed of all.

Its IPO prospectus stated that GSK and Pfizer have been named as defendants in more than 2,000 US personal injury lawsuits involving Zantac. However, the group has stated that it has indemnification obligations with both companies and has never marketed Zantac in the US suggesting the risk goes back up the chain to GSK and Pfizer.

The problem with all of this is the fact that potential liabilities are impossible to estimate. The US legal system is notoriously complex and litigious. What’s more, courts have been awarding ever larger sums to successful litigants and juries are siding with clamints in a thinly veiled fightback against corporate greed.

Johnson & Johnson (NYSE: JNJ) is facing billions in liabilities as courts have ruled in favour of plaintiffs who claim the company’s talc-based baby powder can cause cancer.

Meanwhile, in June 2020 German pharmaceutical and life sciences giant Bayer agreed to pay $10.9bn to settle 95,000 cases against the group arguing that the herbicide, Roundup, caused cancer.

The size of the award is a threat to GSK shares

While there’s a risk GSK, Pfizer, Sanofi and even Haleon could end up facing one of these large judgments, there has been some good news this week.

The first Zantac case was slated to come to trial on August 22, but the plaintiff has now decided to file a Notice of Voluntary Dismissal. GSK claims that it has “not paid anything in exchange for the voluntary dismissal,” and the group believes this is the best outcome as the “overwhelming weight of the scientific evidence” supports the conclusion there is no increased cancer risk from the drug.

This suggests GSK and its peers might get off lightly, but I think it’s too soon for investors to breathe a sigh of relief. GSK has been named as a defendant in as many as 3,000 personal injury cases filed in federal and state courts. With these numbers one thing’s for sure, the pharmaceutical giants face a long, expensive legal battle as they work through the outstanding cases. And if just one case gets through, it could set off another wave of litigation.

So it’s not really surprising that investors have hit the sell button first and are waiting to ask questions later. All of these companies are facing potentially billions of dollars of legal expenses in the best case, and even larger sums of money in the worst case scenario.

Still, I think it’s unlikely these legal wrangles will lead to either company’s demise. Lawsuits are just part of doing business in the US, and both firms will have plans in place to deal with the threat. All the stakeholders also have an interest in agreeing to a deal that both meets claimants’ demands and allows the organisations to continue functioning. Insolvent businesses won’t be any use to anyone.

Growth might suffer as the companies divert cash to fund their legal battles, but it seems unlikely the fallout will be terminal.