Novartis Brings Alcon Into The Fold

By Stephen D. Simpson, CFA | December 16, 2010 AAA

Novartis (NYSE:NVS) shareholders should not begrudge the fact that their management team was willing to put the screws to Alcon's (NYSE:ACL) minority shareholders in the hopes of finishing up the acquisition of this significant eye-care franchise at as low a price as possible. That said, Novartis should also be applauded for seeing reason and finally deciding to offer a fair deal to those Alcon shareholders. Shareholders of companies like Lilly (NYSE:LLY), Bristol Myers (NYSE:BMY) and Sanofi-aventis (NYSE:SNY) might wonder why their management teams are not being similarly aggressive.

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The (Successful) End of the Deal
Whether it was a desire to simply finish the deal or the prospect of fighting the Alcon board in court (essentially paying to fight itself, as Novartis already controlled about 77% of the stock), Novartis abandoned its attempt to jerk around the minority shareholders and offer a fair price. To that end, Novartis announced an agreement whereby it will acquire the rest of Alcon for $168 per share. Novartis intends to do the deal with stock, but will supplement it with cash as needed to maintain the deal value. Simultaneously, the company will restart its multi-billion dollar buyback program to neutralize the impact of these extra shares.

All told, Novartis is paying nearly $52 billion for Alcon - nearly 19 times EBITDA and over seven times book value. If that sounds like a high price, it is, but Alcon is arguably worth it. The company has leveraged its leading position in eye care to produce incredible returns on capital and consistent double-digit growth.

A Long Road
While Alcon offered little ground for complaint in its fundamental quality, it also had something of a takeover premium built into the stock for many years. Nestle (Nasdaq:NSRGY) was the majority owner for quite some time, but nobody ever seemed to think that Nestle was really committed to long-term ownership. Consequently, it was not a tremendous surprise to see Novartis step up, but Novartis arguably could have handled the process better. (For more, see Novartis On The Right Track.)

Novartis originally bought a 25% stake in Alcon for $143 per share, and then later exercised an option to acquire the remaining 52% for $180 per share. At that point, Novartis turned around and offered $153 to the remaining Alcon shareholders. Rightly seeing no reason to accept such a discount, shareholders dug in, complained loudly, and prepared to fight it out with Novartis. The fight lasted nearly a year, but ultimately Novartis offered $168 - the average price that it paid to Nestle in those two deals.

Offering the same price to minority shareholders as to Nestle seems like such a blindingly obvious move (at least from the perspective of fairness) that it leads one to wonder what took so long. But perhaps Novartis management felt that they didn't have to offer more than $153 a share and were going to get the deal done as cheaply as possible. (For more, see Novartis Looks For 20/20 Vision With Alcon.)

Where to from Here?
With Alcon in the fold, Novartis has the leading eye-care business in the market and a bit more diversification away from pharmaceuticals (though much of Alcon's business is in pharmaceuticals). That leaves precious few other options for investors, including Allergan (NYSE:AGN) (which is only partially committed to eye care) and ISTA Pharmaceuticals (Nasdaq:ISTA), which is a very interesting stock, but smaller and riskier than big-cap pharma companies.

As for Novartis, it is anyone's guess as to whether this company is done dealing. The company's stock has been among the best performers in the sector over the past year, and carries one of the higher valuations as well. If the company can find accretive or short-term earnings neutral deals where the targets are willing to take Novartis stock, there is no reason to think that the company would not consider certain specialty pharmaceutical, biotech or foreign deals. (For more, see Where The M&A Action Is, And What's Next.)

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