Healthy Skepticism Library item: 820

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Publication type: news

Timmons H, Wright T.
Novartis to Buy Two Makers of Generics
2005 Feb 22

Full text:

Novartis, the Swiss pharmaceutical giant, said on Monday that it planned to buy Hexal of Germany and its affiliate Eon Labs of New York for $8.4 billion in cash, creating the world’s biggest maker of generic drugs.

Hexal, which had sales of 1.3 billion euros ($1.7 billion) last year, would bring Novartis more than 120 new products, among them painkillers and cholesterol drugs, while Eon would bring a low-cost copy of a popular antidepressant and an extensive pipeline of new generic medicines.

Together with Sandoz, Novartis’s generic drug unit, the companies would have more than $5 billion in sales, and would command 10 percent of the estimated $100 billion market for low-priced copies of brand-name drugs by 2010, Novartis said.

The deal serves to further differentiate Novartis, already something of an iconoclast in the industry, from its peers. As global giants like Pfizer and GlaxoSmithKline focus on high-profit, patented blockbuster drugs and lobby to strengthen patent laws, Novartis has expanded into generics.

The progressive aging of the population is increasing the need for medications as well as the need to keep down health care costs, Daniel L.
Vasella, the chairman and chief executive of Novartis, told analysts on a Monday morning call.

“Generics will continue to penetrate the market,” he predicted. They will grow in Europe and Latin America as well as in the United States, where they already make up 50 percent of sales volume, he said.

The purchase will be conducted in stages: Novartis has already signed an agreement to pay 5.65 billion euros, or $7.4 billion, for all of Hexal and for 67.7 percent of Eon. Hexal’s founders, the brothers Andreas and Thomas Strüngmann, own a majority stake in Eon, which is publicly traded and is based in Laurelton, N.Y.

When that transaction closes, most likely in the second half of this year, Novartis plans to offer $31 a share, or about $1 billion, for the rest of Eon, an 11 percent premium to Eon’s closing price Friday on the Nasdaq.

Bringing Hexal, Eon and Sandoz together would result in $200 million in annual cost savings after three years, Novartis said. The company, which is based in Basel, Switzerland, expects to cut costs in areas where its brand-name pharmaceutical business works with large customers. Novartis may also be able to negotiate lower prices for raw materials, analysts said.

Dr. Thomas Strüngmann will join the company as Sandoz’s head of regional operations in Germany, the Americas and the Middle East, while his brother, Dr. Andreas Strüngmann, will be responsible for Europe, Africa and Asia-Pacific. Both will report to Sandoz’s chief executive, Dr. Andreas Rummelt.

Rating agencies, including Fitch and Moody’s, reaffirmed Novartis’s AAA rating Monday afternoon, but some analysts expressed caution.

“This improves their generic business,” said Britta Holt, an analyst at Fitch. But if Fitch were to rate the generic business alone, it would not command its highest rating, she noted. “The margins are small, as is the return on capital,” she said.

Novartis also has a big brand-name pharmaceutical division, which sold $15.4 billion in 2004, five times Sandoz’s sales, and owns consumer health products like CIBA Vision, a contact lens maker.

Generic drugs would still only account for about 15 percent of Novartis’s sales after the acquisitions, with earnings mostly being driven by patented drugs, like the top-selling hypertension treatment Diovan.

Hexal, headquartered near Munich, is the second-largest generic drug manufacturer in Germany, which is the second-largest market in the world for generics behind the United States. The company is about to introduce fentanyl, a generic painkiller that is delivered through a patch placed on the skin.

Eon is much smaller, but could still provide Novartis with strong growth, analysts said. In October, Eon reported third quarter sales of $110 million,
29 percent higher than a year ago, powered by sales of bupropion, the generic equivalent of Zyban or Wellbutrin, antidepressants that are also being prescribed to help cigarette smokers quit.

Novartis said in a statement that Eon Labs had a pipeline of drugs covering nearly all the products that will lose their patents in the United States from 2005 to 2009. These drugs, which include Merck’s top-selling cholesterol medicine Zocor, represent an estimated $69 billion in product sales over the next five years, Novartis said.

Analysts warned, though, that there might be some pitfalls. Novartis’s strategy of expanding its generic-drug unit carries risks because of high competition, which led to a price collapse last year in the United States, said Mark Clark, an analyst who covers European pharmaceuticals for Deutsche Bank in London.

“You will get volume growth in this market, but it’s a market that’s characterized by cutthroat competition,” Mr. Clark said. Low-cost producers in India and China will probably push hard into the American market as patents expire, he added.

Other analysts said the deal looked expensive. Merrill Lynch said in a report that Novartis was paying four times the two companies’ combined 2004 sales of 1.6 billion euros.

The head of Novartis’s largest rival in the generic field, Teva Pharmaceutical Industries, said Monday that he was untroubled by the deal.

“We will acquire more in the future, but we don’t see a need to respond”
immediately to its new, larger rival, Israel Makov, the chief executive, said. Novartis’s generics business will edge out Teva, which is based in Netanya, Israel, and has $4.8 billion in sales, by just a small amount when the Hexal and Eon deals close, Mr. Makov noted.

Novartis was advised by Goldman Sachs and received legal advice from Wachtell, Lipton, Rosen & Katz. Eon’s special committee of independent directors was advised by Merrill Lynch and received legal advice from Simpson Thacher & Bartlett. Eon was advised by Willkie Farr & Gallagher.
Hexal did not use an investment bank.