2009 Exits/Financings DOTY Nominee: BMS Spins Off Mead Johnson

It's time for the IN VIVO Blog's Second Annual Deal of the Year! competition. This year we're presenting awards in three categories--that's 300% more fake prizes than last year!--to highlight the most interesting and creative deal making solutions of the year. The categories are: Big Pharma Deal of the Year, M&A/Alliance Deal of the Year, and Exit/Financing Deal of the Year. We'll supply the nominations (roughly half a dozen in each category throughout December) and you, the voting public, will decide the winners (by voting early and often, commencing once we've announced all the nominees). Strap yourselves in, it's The Race for the Roger™.

It's no secret that Bristol-Myers Squibb has spent the last couple years solidifying its stance as a pure biopharma play. Is the company better positioning itself for sale? Going all in on the only thing it thinks it does well to try to stick it out for the long haul ahead of a monster patent cliff? In any case, it's an outlier. And its most recent and perhaps final move to focus on prescription biopharma suggests a confidence in that core business--or a last stand.

While BMS purges non-biopharma assets, others are diversifying at breakneck pace. Just yesterday Sanofi-Aventis said it would spend $1.9 billion to make a splash in the US OTC products market, for example.

Meanwhile BMS was busy trading shares of its nutritionals unit, Mead Johnson, for its own shares in a spin-off of the division. Bristol won't receive cash for the deal, but the transaction will be accretive to earnings in 2010 by reducing the number of Bristol's shares outstanding, thus increasing earnings per share. The exchange offer will also be attractive to shareholders because it is expected to be tax free.

The stock-swap follows BMS's decision to sell a small percentage of the company in an IPO that was completed in February. That offering raised $720 million and seemed to give BMS some of the virtues of diversification (it could, as a majority shareholder, still consolidate the nutritionals group's top and bottom lines with its own) but allowed for management focus: it was run as an independent unit.

But Bristol reckoned that those 170 million remaining Mead Johnson shares, if all exchanged, would give it a ten-cent pop in EPS next year. Plus with all those shares retired, the company will improve its cash flow by paying out $350 million less in dividends (er, that's provided it doesn't raise its dividend on the remaining shares, and without subtracting the smaller dividend it got from its MJN holdings). What's more, MJN shares are way up since the IPO, so why not take advantage of that valuation bump?

Essentially, the move prioritizes short-term gain over long-term stability. Proponents of the deal say that's OK, because without some sort of short-term gain to appease investors, BMS might not have a medium- or long-term future in which to let it's string-of-pearls strategy play out.

The bottom line is that BMS needs to keep its rivals at bay by maintaining or boosting its worth in the face of two massive patent expirations (Avapro and Plavix) to make sure nobody can buy them on the cheap. That means good growth from existing and in-line products and potentially spending its $10 billion cash pile on a few more near-market pearls.

That's no easy task, but its two-part parting of the ways with Mead Johnson is a creative and lucrative pair of transactions that puts it in the best position to succeed.

image by flickr user nerissa's ring used under a creative commons license

Bristol Says Buh-Bye to Formula for Stability, Hello to Buyback

It's no secret that Bristol-Myers Squibb has spent the last couple years solidifying its stance as a pure biopharma play. We've documented the moves as they've happened: spinning out orthopedics (Zimmer) in 2001, jettisoning OTC, medical imaging, and wound care (Convatec) in 2005, 2007, and 2008 respectively, and inking deals to divest variety of emerging markets businesses this year and last.

And we like a contrarian argument--BMS is zigging toward focus as the rest of the industry zags toward diversification. Is the company better positioning itself for sale? Going all in on the only thing it thinks it does well to try to stick it out for the long haul ahead of a monster patent cliff? Whatever, it's ballsy, and we think they're all the more interesting to watch because of it.

And we really thought Bristol was onto something interesting when they IPO'd Mead Johnson earlier this year. Back then they convinced us of the merits of offloading a smallish chunk of the nutritionals unit that it is now essentially using to fund a stock buyback. Let The Pink Sheet explain:

In the stock swap transaction, Bristol investors who choose to tender their shares will receive approximately $1.11 of Mead Johnson shares for every $1 of Bristol. Bristol won't receive cash for the deal, but the transaction will be accretive to earnings in 2010 by reducing the number of Bristol's shares outstanding, thus increasing earnings per share. The exchange offer will also be attractive to shareholders because it is expected to be tax free.

So Bristol's 170 million Mead Johnson shares, if all exchanged, would give the biopharma company a ten-cent pop in EPS next year. Plus with all those shares retired, the company will improve its cash flow by paying out $350 million less in dividends (er, that's provided it doesn't raise its dividend on the remaining shares). MJN shares are way up since the IPO, so why not take advantage of that valuation bump and allow management to focus on growing the core business and build on the 'string of pearls' strategy with the $10 billion it expects to have by year end?

Because with or without this buyback BMS has that $10 billion. And management focus was more or less guaranteed when it sold 13% of the company in February 2009. What BMS loses when it takes its Mead Johnson stake down below 50% is the ability to consolidate the unit's sales and earnings. It also loses a relatively strong emerging markets business (Mead's second largest market is China).

The move prioritizes short-term gain over long-term stability. Since BMS sold Zimmer in 2001 the orthopedics company's value has doubled while BMS's has more than halved. The IPO strategy would have worked well there--BMS could have held on to some of that value and cash flow--and it seemed to be working well with Mead Johnson. The cash flow gains from this buyback are a band-aid on the wounds inflicted by the loss of exclusivity on Plavix and Avapro (40% of 2008 revenues). Why not pursue some middle ground while keeping a majority stake in the company?

Back to the 'Sheet for Bristol CEO Jim Cornelius' answer:

"We've always said that one of the main considerations in retaining our ownership position in Mead would be our confidence in the strength and sustainability of our biopharma business in 2013 and beyond," Cornelius said. "The split is a sign of that confidence, as we have made excellent progress in advancing our biopharma business in addition to the new product portfolio."

We aren't arguing that his confidence is misplaced. But BMS could continue to strengthen its biopharma business even with Mead's as an outrigger.

image thanks to flickr user joel p under creative commons license

Investors Dig Baby Formula, Not Yet Ready for Solid Foods

Against the odds and a miserable market Bristol-Myers Squibb milked investors for $720 million yesterday. According to Reuters, BMS sold 30 million shares in Mead Johnson Nutritionals at the top end of its previously announced $21-24 range.

MJN, which begins trading on the NYSE today, only feels like the first IPO in about seventeen years. But it is the first health care IPO in the US since 2007. Still, nobody seems to be kidding themselves that Mead Johnson's introduction to the public markets means anything for the rest of the industry's IPO hopefuls.

But the deal is huge for BMS, which has continued to execute on its specialization strategy designed to remake the company as a pure play biopharma. Now, to paraphrase the old chestnut, BMS gets to have its baby formula and drink it too.

As we wrote last September, by maintaining an 85% stake in Mead Johnson as well as the lion's share of voting rights in the company, BMS gets to achieve its sought-after managerial focus while at the same time clinging onto the benefits of owning a diversified portfolio of assets.

As long as it keeps more than half of the Mead Johnson shares, it will be able to consolidate Mead's top and bottom lines, subtracting the proportion of net income attributable to the minority shareholders only at the very bottom of the P&L, in minority interests.

"I recognize that the drug industry is more uncertain today than 15 years ago," BMS CFO Jean-Marc Huet told IN VIVO last year. And that the outlook for Mead Johnson's industry "is far more stable." (The nutritionals company is expected to grow faster than BMS's core drug business.) But in spinning off those MJN shares, "we haven't increased Bristol's risk profile since we still consolidate its sales and earnings," he said. Likewise, it can even take its pro-rata share of Mead Johnson's cash flow--so won't face the same criticism Pfizer has with the sale of its OTC business to Johnson & Johnson in 2006, or even Bristol itself with the spin-off its orthopedics group Zimmer Holdings in 2001. (Zimmer shares have appreciated significantly since then, while BMS's have been roughly halved.)

Meanwhile, Bristol's managers can focus 100% of their attention on the pharma business and dealing with the 2011 patent expirations of both Plavix and Avapro. Freed from the other businesses, Bristol managers won't get clouded with their issues. And with Mead Johnson traded separately, followed by a different group of analysts, it should get the benefit of their attention, rather than being ignored by drug-stock researchers.

Could other Big Pharma benefit from a similar strategy? Novartis is well on its way to achieving a similar arrangement with Alcon (a deal we spent considerable time analyzing as part of our DOTY competition). Pfizer seemed headed towards a more concrete restructuring when it split out its various business units last year. Now that it plans to add Wyeth's consumer and vaccines businesses to the mix (presumably Wyeths biologics and small molecule drugs will get lumped in with Pfizer's pre-existing business units) perhaps a similar argument can be made there.

It could surely use the proceeds to pay down that expensive debt.

image by flickr user nerissa's ring used under a creative commons license

Deals of the Year Nominee: Novartis/Alcon

Ah, awards season. Why should film critics have all the fun? And voting! It's not just for presidential elections. This year your IN VIVO Blog team is nominating a handful of alliances, acquisitions, financings, regulatory negotiations and legislative compromises in our First Annual DOTY competition. And then you, dear readers, will vote (early and often, we hope) for the winner. Imaginary federal and international biopharmaceutical statutes prohibit us from awarding a monetary prize. But our winners, when they die, on their deathbeds, they will receive total consciousness. So they've got that going for them, which is nice.

The more legs you’ve got, the more stable you are when you’re standing still. But how do you get all those legs moving in synch?

Attitudes vary towards just how much diversification is worthwhile, but – with just a few holdouts -- drug companies agree that basing a business on novel small-molecule research is way too risky.

But as with multi-legged creatures, the problem with diversification is how managers good at (or at least familiar with) running one kind of business – R&D-intensive prescription drugs – do with another kind. Which is why the more conservative of the diversifiers aren’t actually getting out of the drug business per se – by going into branded generics or OTC medicine they’re still staying close, theoretically, to home. Take the most recent convert to diversification – Merck: its recent announcement that it would be going into follow-on biologics edges it toward a kind of generics but without the full-blown commitment to just-in-time product development and manufacturing and rock-bottom prices that the small-molecule end of that business requires.

Novartis, too, certainly recognizes the managerial challenge of diversification. Among the most aggressive of the industry’s diversifiers with extensive consumer and generics businesses, it moved this year even further afield through its play for Alcon (see our transaction summary here and a longer analysis here) – another nominee for deal of the year. Alcon’s largest and fastest growing business is in largely self-pay surgical products, which make up 45% of its total revenues. The consumer side of ophthalmology makes up another 15% -- the rest is specialty eye drugs.

Novartis is trying to minimize the problems of a pharmaceutical company managing a device business in part through the structure of its deal. Novartis is merely investing in the company (starting out with a 25% stake -- for $11 billion -- with a plan to increase it, sometime between 2010 and 2011, to 76%, for no more than an additional $28 billion). It theoretically won’t be managing Alcon any more than Alcon is managed by its current majority owner, Nestle. Instead -- once it owns a majority of Alcon’s shares -- it will be able to consolidate Alcon’s double-digit-growth-sales-and-earnings but without the executive headache of actually running the business. And with Alcon trading independently, investors should still be able to independently follow and profit from its progress, and with luck according it a bigger valuation than what it might receive hidden inside the much larger and slower-growing overall Novartis business.

The disadvantage: with Alcon as an independently trading company, Novartis can’t do the usual cost-cutting most acquisitions allow; nor will it be able to combine marketing efforts (e.g., between Novartis’ ophthalmic businesses in its Ciba Vision contact lens unit or its two eye drugs, in particular the macular degeneration drug Lucentis.

The closest recent comparator we know of to the Novartis/Alcon deal is what Bristol-Myers Squibb is trying to achieve in spinning off of its consumer nutritionals business, Mead Johnson (see our analysis, here). Bristol, too, wants to get the benefit of non-pharma growth without having to manage it. The company figured its pharma-oriented execs couldn’t pay quality attention to the much smaller and much different nutritionals unit; and that when they did pay attention to it, these earnest auslanders probably didn’t add significant value. Investors, too, ignored the group – Big Pharma analysts, hardly experts in the area, buried the Mead results in their spreadsheets.

By spinning off just 10-20% of Mead, Bristol opens up the company for investor examination, frees its own managers to focus 100% of their attention on the pharma business, and focuses Mead’s execs on the competition in nutritionals, rather than the competition for corporate resources. Meanwhile, Bristol still gets to consolidate Mead's top and bottom lines.

So far, quite similar. The big difference between the two deals is that Novartis is paying for its diversification (and had it waited six months, it could have saved 50% or so on its $11 billion down payment); Bristol wants to get paid (albeit the market meltdown will presumably lower the take it had hoped for).

And from an investor’s point of view, Novartis is therefore asking its shareholders to fund its attempt to do what investors might see as their job – buying stock. Since it’s leaving Alcon independent, Novartis can’t argue that its money will be adding much corporate value to the ophthalmic company. One could argue, on the other hand, that Novartis is limiting investor choices: because they could buy Alcon shares on their own, shouldn’t Novartis do something with their money that investors couldn’t (like buy pipeline)?

On the other hand, Bristol’s spinoff actually offers investors a new choice – if they prefer to unload pharma shares for stock in a nutritionals business, well, the menu of choices just got bigger (and theoretically Bristol wins either way). The real strategic equivalent: Novartis could spin off a minority of its generics business, Sandoz, which likewise has virtually no synergies with its parent and which might profit from some independence.

Or you could argue that Novartis is in fact offering investors a new set of choices. Those with a higher appetite for risk can put their money into Alcon; those who want the security of a big company, but now with a frisson of mid-size company excitement, can buy Novartis stock leavened with Alcon growth.

Image via Funny-Dog