Monday, December 15, 2008

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


Anonymous said...

This might be a sweet deal for Novartis but for those of us at Alcon it sucks....they are already destroying our corporate culture, much like the Germans marched through Poland, 65 or so years ago!

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