Novartis' Potent Cocktail

Is its stake in Roche the prelude to a merger?

Years spent as a pharmaceutical sales rep in the U.S. taught Daniel Vasella, the chairman of Swiss drugmaker Novartis (NVS ), the art of schmoozing. Those skills are likely to come in handy now that Basel-based Novartis has snapped up a 20%, $2.8 billion stake in crosstown rival Roche Holding Ltd. from Martin Ebner, the maverick Swiss investor. Unlike the pugnacious Ebner, Vasella is careful to sugarcoat his intentions. "It's a strategic long-term investment for us. Roche is a solid company with good research and a good network of alliances," Vasella said in an interview.

Strategic holding or a prelude to an eventual merger? Both sides deny a deal is in the works. But the appeal is obvious. Their union would give their Swiss hometown the world's third-largest pharmaceutical company with combined drug sales of $20 billion and a market value of $179 billion. A hypothetical Novartis-Roche would control 7% of the global drug market and would be the world leader in immunology, No. 2 in anti-infective and viral medicines, and No. 3 in oncology. Moreover, Vasella could get merger-related savings of around $1.5 billion.

As head of the world's sixth-largest drug company by sales, the charismatic, 48-year-old Vasella is bound to have a smoother relationship with Roche board members than Ebner. "A merger hasn't been discussed," Vasella says. "But there are lots of opportunities for cooperation and collaboration."

Ebner has long been a thorn in Roche's side, demanding management restructuring, a seat on the board, and reform of the 104-year-old drugmaker's antiquated share structure. Roche's two-tiered stock gives the founding Hoffmann family majority control with just 10% equity. The Hoffmann family and Roche management have kept up a solid front on keeping the company independent.

But the ongoing decline in Roche's sales and global position may lead them to reconsider. Roche has been hurt by a handful of failed drugs and disappointing sales of key products such as antibiotic Rocephin and anti-obesity drug Xenical. Drug sales, which account for two-thirds of the company's overall revenues, grew only 1% last year, compared with average double-digit growth rates for the global drug industry. More worrying, the company is a weakling in the U.S., the world's fastest-growing drugs market. Roche shares have fallen substantially in the past year.

Meanwhile, Novartis is embarking on a record growth spurt. This year alone it will launch five new drugs with 11 more hitting the shelves by 2004. Many of the drugs in the pipeline, such as Gleevec, a leukemia drug that could be on the market as early as the end of May, have blockbuster potential. In test trials, all patients given Gleevec went into remission. Now there are indications that the drug is equally effective in reducing certain types of cancerous tumors. And a handful of existing medicines also look promising. High-blood-pressure medication Diovan is likely to be approved for the treatment of heart failure and is forecast to rake in sales of $1.4 billion within the next three years.

TOUGH TALK. While Vasella soups up his vehicle, Roche is hurrying to keep pace. This summer Roche plans to cut between 5,000 and 8,000 jobs from its global workforce. Once this cost-cutting is complete, Roche might seek to do its own deal with a European or American drug company of similar size. When that subject comes up, Vasella talks a little tougher. "I am happy to see Roche making progress by themselves, because it increases the value of our stake," he says. "My only concern would be if Roche entered a transaction with an American company. That would be an issue for me." In other words, he might make a counteroffer.

At least in the short term, such a deal would benefit slower-growing Roche more than Novartis. But as Vasella himself notes: "You don't get something without paying for it." And assuming a deal eventually happens, Vasella's well-honed sales skills will be put to the test.

By Kerry Capell in London

    Before it's here, it's on the Bloomberg Terminal.