Novartis repeats possible spinoff for Alcon eyecare unit; the best laid plans gone awry?

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The News:

Novartis AG (Basel CHE), which spent several years and more than $50 billion acquiring the Alcon eye-care company, signaled it’s ready to give up on most of the business.

@Novartis spent $50 billion acquiring Alcon, but is now ready to give up on it Click To Tweet

After more than a year of efforts to turn around Alcon, Europe’s second-largest drugmaker on Wednesday (January 25, 2017) said it was considering all options for the embattled division, including a spinoff or initial public offering (IPO).

Novartis stripped eye drugs from the unit last year, leaving it with surgical equipment and contact lens operations that are valued at about $20.5 billion on its balance sheet. Despite the steps to improve operations, Alcon’s profit plummeted 31% in 2016, Bloomberg points out.

In recent months, Novartis had considered selling parts of Alcon, including the division that made devices for eye surgery, people familiar with the matter said, asking not to be identified because the plans were private.

A spinoff or IPO of the business may now be the best option as finding buyers has proven to be challenging, the people said. The company weighed selling its contact lens operations in 2015, people with knowledge of the discussions had said previously.

“Now is the time for us to take a look at what’s in the best interests of Novartis shareholders for that unit,” CEO Joe Jimenez said. “This is going to include all options, including retaining the business to exiting the business.”

Jimenez signaled in a conference call that the business could command a valuation in the range of $25 billion to $35 billion, making it an “attractive” asset for investors at a time when there’s a scarcity of healthcare companies with that level of market capitalization.

Novartis expects to provide an update on its review of the options for Alcon by the end of the year.

The Swiss company had made improving operations at Alcon one of its five priorities last year. It appointed a new manager last year and injected funds to bolster the division’s customer service and make small acquisitions as it sought to revive sales.

Other steps included moving Alcon’s drugs to the pharmaceuticals division a year ago.

Those medicines accounted “for a very large percentage” of Alcon, Jimenez told reporters. “We’re starting to see a turn on that business,” Jimenez said. “As long as Alcon returns to growth–the average growth rates and average margins in the industry–we don’t anticipate (a loss)…when we do the impairment testing.”

Shares of Novartis closed the week up 2% to $72.21 in New York. The stock fell about 15% last year.

Steve’s Take:

What was it Robert Burns said about the best-laid plans of mice and men?

This latest Alcon-based story, billed as a new “news” event, actually flew under the radar of many of until last September.

Novartis CEO Joe Jimenez had imposed a deadline of the end of the year for the flailing Alcon unit to get on an upward sales trajectory, a move that has led many of us to think he might just spinoff the unit if it missed the mark. But it was an off-the-cuff remark by another Novartis executive that stoked the embers of a much different divestiture notion.

At an M&A conference in Zurich Sept. 15, General Counsel Felix Ehrat would not rule out a sale of Alcon, Reuters reported. He pointed out that Alcon’s standing as a contacts and surgical instruments maker fits Novartis’ criteria of having units that lead in their markets.

But when asked if that meant Novartis would not sell Alcon, he stepped away from that commitment.

“Never say never,” Ehrat said.

Hmmm.

The suggestion that Novartis would sell the unit has been in the air, FiercePharma points out. And then more recently, Kepler Cheuvreux analyst David Evans wrote in a note to investors that “Alcon will either be fixed or sold,” according to Reuters.

If Novartis disconnects itself of the eyecare giant, it would mean that Novartis Chairman Joerg Reinhardt will have completely refuted the big diversification drive of his predecessor Daniel Vasella, whose exit the board orchestrated in 2013.

When Reinhardt took the reins, he immediately embarked on an “asset review” that resulted in Novartis’ major moves the next year to swap assets with GlaxoSmithKline and sell its animal health business to Eli Lilly.

It traded off its vaccines business to Glaxo for oncology assets and struck a joint venture deal for the UK drugmaker to take control of its consumer health operations. After that $25 billion worth of transactions, only Alcon remained as a major piece of the Vasella diversification era.

Sales at Alcon have been falling for several years and were down slightly last year to $5.8 billion, FiercePharma notes. Those struggles at the unit led Jimenez to unveil a turnaround plan a year ago and to bring in F. Michael Ball (pdf), who had turned around Hospira before its $15 billion sale to Pfizer. But at the JP Morgan Healthcare Conference this month, the CEO said that the turnaround he had hoped would bear fruit this year is taking “a bit longer.”

CEO Jimenez now enhances the divestiture scenario by adding that all options are open, although a spinoff or IPO has at least one enticement: an independent Alcon would “pad out the small universe of $25-$35 billion healthcare stocks,” says Max Nisen for Bloomberg.

Way back in college I learned I reeked at poker, the ponies, even pitching quarters. So I gave that stuff up. Okay, maybe the California lottery on occasion.

However, if I were to speculate about the chances of Novartis chucking Alcon? I’d say yes. Why? I’d argue why not? The Swiss behemoth doesn’t need the money, but definitely can do without the distraction. Alcon was meant to counter weakness in the Novartis pipeline. To the contrary, it’s morphed into a full-fledged stinker of a problem all on its own.

Steve's Take: @Novartis doesn't need money from Alcon sale, but can do without the distraction Click To Tweet

Without it, Jimenez could focus on building the pharma business as it faces the loss of billions in sales from franchise leukemia drug Gleevec to generic competition. Entresto, a heart medicine Novartis expects to peak at $5 billion in annual revenue, missed already low fourth-quarter sales expectations by double digits despite hiking investment in its launch.

Alcon had $5.8 billion of sales last year and Jimenez is quite correct to say it would get noticed if it achieved a $25-35 billion value. Bloomberg’s World Pharma index has just six companies capitalized in that range. The next bracket begins at about $45 billion with the likes of Shire PLC and Merck KGaA. Then come the big boys, starting with AstraZeneca, capitalized at a mere $67 billion.

The paucity value would favor an IPO. Companies thusly capitalized are more eye-catching targets for big pharma because they tend to have meaningful sales or offer scope for M&A-related cost-cutting. That’s why Medivation, and then Actelion, drew such interest.

But Alcon must do more than just fill out a thin part of the pharma landscape. Novartis first needs to achieve its goal of returning Alcon to growth. At least the business stabilized in the fourth quarter, in part because some of Alcon’s declining drugs have been transferred to other parts of Novartis.

“With the market shift to daily disposable lenses, Novartis will be questioning whether the lens-care business is core or unnecessary,” Mirabaud Securities analyst Nick Turner told Bloomberg early last year. “On the one hand it is high margin and will be a loss to division cash flow, but if Alcon continues to be a drag on group performance, its days could be numbered.”

Meanwhile, Nisen opines that,

“All in all, there are probably better owners (than Novartis) for Alcon–and better uses for the Novartis capital tied up in it.”

Not being a betting man, I’d side with Nisen and Turner that as 2017 progresses the forces that have brought Alcon to where it stands vis-à-vis its parent are too akin to a small tidal wave. At least let’s see the first-quarter numbers and then assess whether the surf’s still up before betting the ranch on an outright sale.