Novartis aims to corner generics market

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Pharmaceuticals giant Novartis is making no secret of its intention to corner the potentially enormous global market for "copy-cat" drugs.

The Basel-based company announced on Monday that it would shell out nearly SFr10 billion (almost $8.5 billion) – in cash – to secure its position as the world’s leading producer of generic drugs.

The decision to buy privately-owned German company Hexal and its United States strategic partner, Eon Labs – two-thirds now and one third later – has provoked mixed reactions.

Some analysts say Novartis has paid well over the odds for an acquisition in a sector with very low financial returns.

However, others say the Swiss company is making a long-term investment that could be repaid handsomely – with a dominant position in what is likely to be the biggest growth sector in the industry worldwide.

“It is unavoidable that generics will have to grow if governments and health care players really want to keep costs down,” Credit Suisse analyst Luis Correia told swissinfo.

“There have already been a lot of initiatives in this area, both in the US and in Europe. I think that Novartis has read the industry dynamics the right way.”

Bucking the trend

Promoting the market for generics – cheaper versions of drugs that have lost patent protection – represents a major political opportunity for governments and other health care providers looking to combat rapidly escalating health costs.

However, most big pharmaceutical companies are still treading warily in this area, because low market prices mean the immediate returns are not as high as on patented drugs.

Sandoz, the Novartis business unit for generics, had an operating profit margin of just 7.7 per cent in 2004 – roughly one-quarter of that of the Novartis pharmaceuticals division as a whole.

Novartis is clearly bucking the trend – since launching Sandoz as a global unit just two years ago, it has already purchased Canada’s Sabex (for $565 million) and Slovenia’s Lek Pharmaceutical & Chemical (for $1 billion).

But the latest acquisitions are by far the biggest yet.

“Generic drugs are crucial to meeting the healthcare needs of patients in industrialised and developing countries as cost pressures continue to mount due to the ever increasing demands of an ageing population,” said Chairman and CEO Daniel Vasella on Monday.

“As such, generic medicines are a critical complement to innovative medicines, freeing up resources and also providing an indirect stimulus to continued innovation.”

Vasella told last month’s annual financial results meeting that the long-term goal of investing in generics was to “make generics obsolete, by bringing products that have a better safety efficacy profile”.

Long-term prospects

Analyst Correia says that it is the growing use of generics in the prescription drugs sector, rather than current sales, which is of crucial importance to Novartis’ strategy.

“Novartis is relatively unique in focusing so much on generics, but that is not to say that the strategy is wrong,” he said.

“This is a long-term industry. If you look at the long term, Novartis is clearly an outperformer, both on the Swiss and international markets.”

Some analysts are less convinced. Birgit Kuhlhoff of German private bank Sal Oppenheim pointed out that Novartis was paying nearly four times the current combined sales of both companies it had acquired.

However, Novartis argues that the deal will provide it with the necessary scale to cut costs aggressively in a market where cut-throat competition and growing price pressures are the order of the day.

It adds that the acquisitions will provide it with a combined pipeline that covers “nearly all the major molecules” predicted to lose patent protection within the next few years.

Jumping on the bandwagon?

A recent report by Kepler Equities showed that, in the anti-depressant category – which accounts for nearly 12 per cent of spending in some prescription drug plans – increased use of generic drugs could cut overall costs considerably.

The report added: “[From the companies’ point of view], things will only get worse. Generic versions will soon encompass the majority of current sales for a number of therapeutic classes.”

This is likely to hit earnings in two ways – directly, as patents expire, and through generic substitution, as the number of treatment options for patients increases.

Novartis believes that, by jumping on the bandwagon now, it will be able to outperform key competitors in years to come – once the market for generics really opens up.

Several analysts agree, saying that acquisition prices in the pharmaceuticals industry today should be measured not just in terms of current sales multiples or direct comparisons.

“They should be measured also in terms of the fact that the cash is available… and needs to be put back into growth,” Correia told swissinfo.

“At the moment, Novartis will not have much cash left, but it has a very strong balance sheet and can leverage this if it wants to.

“They also have a very stable cash flow going forward. A year from now, they will again have a couple of billion dollars to spare.”

swissinfo, Chris Lewis

Key facts

Novartis comprises two main divisions: Pharmaceuticals and Consumer Health.
Sandoz, the company’s generic drugs business unit, belongs to the Consumer Health Division.
It employs about 13,000 people worldwide and had 2004 sales of some $3 billion – more than 10 per cent of the company total.

In brief

By purchasing Germany’s Hexal and US strategic partner Eon Labs, Novartis will become the biggest generic drug maker worldwide.

The price paid – SFr8.75 billion now plus SFr1.17 billion later – is expensive in standard valuation terms.

However, Novartis may be stealing a march on competitors by investing in the growth market of the future.