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Excessive legal risk could create opportunities for a few persistent people

Excessive legal risk could create opportunities for a few persistent people

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The common view of legal risk – just think of major class action lawsuits in the US – is that it makes a company virtually uninvestable. The potential liabilities are completely unpredictable. Financial analysts’ initial estimates often turn out to be too optimistic. But some recent cases challenge this view.

Zantac – a discontinued blockbuster heartburn drug once marketed by GSK, Sanofi and Pfizer, among others – is one such case. The threat of litigation over the alleged cancers came to the attention of the financial world in the summer of 2022, when an analyst report put the potential liability at between $3 billion and a whopping $45 billion. At the time, investors wiped around $40 billion from the affected stocks.

Line chart of stock prices, recalculated on a pence basis, shows that drugmakers affected by Zantac swallowed a bitter pill in 2022

Two years later, many cases have been settled or dismissed, although the turbulent news cycle continues to roil share prices, particularly those of GSK. However, analysts now estimate the British pharmaceutical company’s potential liability at between $3 billion and $6 billion, compared to the original estimate of $3 billion to $27 billion.

Similarly, Philips settled a lawsuit related to its sleep apnea devices earlier this year for $1.1 billion, a fraction of what analysts had expected. Reckitt’s potential baby formula-related liabilities are still pending, but here too market forecasts are declining, from $12 billion once to as much as $3 billion today.

All of this requires some obvious caveats. Two or three swallows do not make a summer. And Reckitt’s situation in particular is still so preliminary that it would not be surprising if market estimates were to fluctuate considerably from here.

However, it seems at least plausible that analysts – who have burned their fingers in spectacular legal disasters such as Bayer’s legal battle over Roundup weed killer – would prefer to err on the side of caution in some cases. That would be understandable. Given the uncertainty, it is a futile exercise to put any numbers on paper.

At least recent cases suggest that legal risk is a two-way street. Overreactions create a potential opportunity. That’s hard to capitalize on, of course. For professional money managers, taking a large position in a stock with a known legal risk can be career-ending. And even if they’re right, courts are slow. In the meantime, many other things can go wrong with the company.

Some investors believe that legal risks are worth taking. The Italian Agnelli family invested in Philips from a long-term, fundamental perspective. But that will probably remain the minority opinion.

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