Novartis Banks on Meningitis Shot to Justify ‘Oops’ Deal

Novartis AG’s (NOVN) troubled acquisition of Chiron Corp.’s vaccine business has one last hope -- approval of a shot to protect against a meningitis-causing bacteria.

Winning European Union backing this year for Bexsero would help salvage the company’s vaccine unit, which it created with the $7.5 billion acquisition of Chiron. Failure, on the other hand, may prompt Novartis to sell or scale back the unit into which the company has poured billions of dollars in funding for little return. And years of delays have raised concerns that Bexsero may be the next to flop.

“If the division flunks, does that mean a restructuring? Possibly,” said Michael Leuchten, an analyst at Barclays Plc’s investment-banking unit in London. “Does it mean a disposal? Possibly. Those are both scenarios that I’ve discussed with people close to management.”

Novartis’s predicament is emblematic of a broader bind afflicting the industry, one that’s existed for years but is now coming to a head. Like other drugmakers, Novartis has embarked on acquisitions in part because its own labs haven’t produced enough new products to replace branded-drug sales that it’s losing to generic competitors. Yet the recent track record of some other pharmaceutical companies’ large bets on experimental products shows how flawed that strategy can be.

In August, Bristol-Myers Squibb Co. scrapped a hepatitis C pill it bought for $2.5 billion in January after a patient died while taking the drug and others were hospitalized. Merck KGaA is closing the headquarters of its Serono drug unit after the division it bought in 2007 for 16.6 billion Swiss francs ($17.6 billion) failed to deliver new products.

Vasella’s Strategy

Novartis bought Chiron in two chunks 11 years apart as part of a strategy by former Chief Executive Officer Daniel Vasella to diversify into areas outside of prescription pharmaceuticals.

The deal, completed in 2006, gave Novartis a set of blood tests for viruses including HIV and hepatitis, and access to the global vaccines market, which it said would double to more than $20 billion by 2009. The market kept its end of the bargain, reaching $22.1 billion in 2009 according to Rockville, Maryland- based Kalorama Information.

The performance at Novartis’s vaccines and diagnostics division has been another story. Sales peaked at $2.9 billion in 2010 on revenue from influenza vaccines sold during the H1N1 flu pandemic. Last year the business had revenue of $2 billion and a $249 million operating loss. Sales in Chiron’s vaccines and diagnostics units were $1.25 billion in 2005. The company’s drugs business was folded into Novartis pharmaceuticals.

R&D Investment

“Oops,” said Birgit Kulhoff, a money manager at Rahn & Bodmer Co. in Zurich who owns Novartis shares, when asked how she views the Chiron acquisition in hindsight. “I don’t really see a big future for the vaccine business for Novartis,” she said in a phone interview.

While the division’s sales have “done okay,” investments in research and development have hurt profitability without producing much in the way of new products, Leuchten said. Menveo, a vaccine against four strains of bacteria that cause meningitis, was introduced five years after Sanofi (SAN)’s Menactra. The Paris-based drugmaker’s shot garnered sales of 427 million euros ($549 million) last year, compared with $142 million for Menveo.

If approved, Bexsero would be the first vaccine to protect against the meningococcus B bacterium, a bug that’s the main cause in Europe of meningococcal disease, a malady that mainly affects children and can cause brain damage, hearing loss and death.

Delayed Approval

Approval has been delayed on requests from the EU regulator for more information. Late-stage trials haven’t started in the U.S., where the company is discussing with the Food and Drug Administration how the studies should be designed. In 2008, Novartis said the shot might be available by 2010.

Even if Bexsero is approved in Europe, Novartis may have its work cut out convincing austerity-conscious governments to pay for a vaccine against a disease that strikes fewer than one person in every 100,000, Leuchten said. He’s forecasting sales for the shot of $200 million in 2015.

Novartis declined to make Chief Executive Officer Joe Jimenez or Andrin Oswald, the head of vaccines, available for an interview on the division. Jimenez told analysts in January he was confident Bexsero would win regulatory backing and make the division successful.

“Now if that doesn’t happen, then obviously, we have to rethink that, because we’re not going to continue to accept losses in the division,” Jimenez said on a conference call.

Novartis reiterated in a statement last week it expects to start selling Bexsero next year, “which will represent a great success for the division.”

Trigger for Profitability

“Since the Novartis acquisition of the vaccines business in 2006, we have maintained a consistent position that it is a long-term investment to develop the promising pipeline of new vaccines, led by the meningococcal portfolio with Menveo and Bexsero, as the trigger to take the division to profitability,” the company said in the e-mailed statement.

Novartis may decide to sell the two pieces of the division separately, with vaccines fetching about $6.3 billion and diagnostics getting a price of $1.3 billion, Jeffrey Holford, an analyst for Jefferies & Co., wrote in a Sept. 27 report.

Still, vaccines is an attractive and potentially lucrative business because governments increasingly see them as a way to save money by preventing diseases, and because the complexities of making them mean there’s no threat from generics, said Gbola Amusa, an analyst at UBS AG in London.

Growth Component

“It’s perhaps the most important therapeutic category in modern health care,” Amusa said in a telephone interview. He forecasts Novartis’s vaccines division reaching $4.2 billion in sales by 2017. “It’s a bit premature to say Novartis should sell this business when it could soon become a very important component to growth.”

Some of Novartis’s deals, such as the $50 billion acquisition of Alcon Inc. to create an eye-health division, have paid off, Barclays’ Leuchten said. “It did give them what they wanted, which is another leg to stand on and a sustainable business,” he said.

The Chiron deal looked like a good idea at the time because it lessened Novartis’s reliance on pharmaceuticals, said Eleanor Taylor Jolidon, who manages about 300 million francs, including Novartis shares, at Union Bancaire Privee in Geneva. Now she’s changed her mind.

“For what they paid and what they promised, it was a bad deal,” she said. “To validate it, not as a good deal, but as a justifiable move, then they need something to happen.”

To contact the reporter on this story: Simeon Bennett in Geneva at sbennett9@bloomberg.net

To contact the editor responsible for this story: Phil Serafino at pserafino@bloomberg.net

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