Behind Novartis' Eye-Popping Buyout

The Swiss drug giant's $39 billion deal for Alcon will give it fresh avenues for growth -- and further expansion into ophthalmic care

With sales of prescription drugs expected to slow, Swiss pharmaceutical giant Novartis (NVS) announced on Apr. 7 it will acquire Alcon (ACL), the world's largest and most profitable eye-care company, in a deal potentially worth $39 billion. Novartis will pay $143.18 per share—a price based on Alcon's volume-weighted average share price between Jan. 7 and Apr. 4—about 3.5% less than Alcon's $148.44 closing price on Apr. 4.

It's the culmination of several years of discussions off and on between Novartis and Alcon's majority owner, Nestlé (NESN.DE). Novartis, which had 2007 revenues of $39.8 billion, initially will buy a 25% stake in Alcon for $11 billion, with exclusive rights to acquire Nestlé's remaining 52% stake for $28 billion between January, 2010, and July, 2011. Alcon's revenues amounted to $5.6 billion last year. "This enables us to take advantage of a major growth opportunity while diversifying risk," Novartis Chairman and Chief Executive Officer Daniel Vasella told BusinessWeek.

The deal and its eye-popping price tag indicate the intensity of the challenges facing the pharmaceutical business worldwide. Drugmakers are under intense pressure from governments, insurers, and consumers to curb soaring prices. At the same time, industry productivity is waning as the cost of research and development soars.

Patent Crunch

Complicating matters, generic drug companies are successfully challenging patents on the pharmaceutical industry's biggest money-spinners. And regulators around the world, led by the U.S. Food & Drug Administration, are becoming much more cautious about new drug approvals. "In this environment, you have to ask yourself: How do I want to position the company?" Vasella says.

The answer, he says, is to be a diversified health-care business not overly reliant on cutting-edge pharmaceuticals. It's a strategy Vasella has been pursuing for nearly a decade. Recognizing consumer demand for cheaper drugs, he splashed out $13 billion to acquire German generic drugmakers Hexal and Eon Labs in 2005. Today, the Swiss company's generic business, Sandoz, is No. 2 worldwide, behind Israel's Teva (TEVA). In 2006, Novartis paid $5.7 billion for U.S. vaccine maker Chiron. And all along, the company has continued to build its over-the-counter and Ciba Vision optical units (the latter overlaps with Alcon in contact lens solutions). "We were never a pharma pure play," Vasella notes. "And it's getting harder to find good opportunities for acquisitions in pharmaceuticals."

Nevertheless, Novartis faced a number of setbacks last year. At the request of the FDA, the company withdrew Zelnorm, a drug for irritable bowel syndrome, from the market because of links to an increased risk of heart attack. U.S. approval was delayed on Novartis' new diabetes drug Galvus. Painkiller Prexige was once viewed by the company and analysts as a potential blockbuster. But as part of the same COX-2 class of drugs as Merck's (MRK) ill-fated Vioxx, it is now unlikely to gain U.S. approval.

Vasella knows Novartis needs to find new sources of growth. Within the next four years, approximately one-third of the company's revenue sources will face generic competition, according to analysts at Morgan Stanley (MS). Novartis' best-selling drug, blood pressure medication Diovan, with sales of more than $5 billion, will be the biggest casualty when it loses patent protection in 2012.

Greener Pastures

What Alcon offers Novartis is access to a fast-growing specialty health-care business, whose business spans prescription drugs for eye diseases such as glaucoma, over-the-counter products such as Opti-Free contact lens solutions, and medical devices and products for ophthalmic surgery. Analysts say it meshes well with Novartis' Ciba Vision business and with the company's Lucentis, a fast-growing drug for age-related macular degeneration, a leading cause of blindness in the elderly. Novartis acquired the rights to sell Lucentis outside the U.S. from Genenetech (DNA). The drug is expected to generate revenues for Novartis of just under $1 billion in 2008.

An even bigger attraction for Novartis is that Alcon's sales come from diversified sources, ranging from consumers to managed-care providers, making it less vulnerable to price regulation and a potential slowdown in consumer spending. Instead of depending mainly on managed-care providers or governments for sales, as is the case with prescription drugs, Alcon gets a sizable chunk of its business from customers who pay out of pocket for over-the-counter products or procedures such as laser eye surgery.

Alcon also should help Novartis in developing economies, where the eye-care company is growing fast. It's the lead player in the $2.5 billion global cataract surgery market—a franchise set to boom in emerging markets, where the procedure is only now starting to become popular. Last year, Alcon's sales in developing markets grew 21%.

Still, the reaction to the deal was muted. Novartis' shares, already down 18% year to date, dropped a further 1.4% in Swiss trading by day's end and were off 3% by midday in New York. "With Alcon, Novartis is buying a quality business at attractive terms," says Karl Heinz Koch, a pharmaceuticals analyst at Bank Vontobel (VONN.DE) in Zurich. "But Novartis would have been better served by addressing some of the issues in its core pharmaceuticals business before it started diversifying."

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