Sanofi Has To Do Something

By Stephen D. Simpson, CFA | July 30, 2010 AAA

The problems facing French drug giant Sanofi-Aventis (NYSE:SNY) these days are nothing out of the ordinary for the big-cap pharmaceutical sector. The company is facing some major generics competition and has very little in the way of potential blockbusters to immediately replace that revenue. On top of that, Wall Street's growth addiction has left the shares languishing.

The question now, though, is what Sanofi's management is going to do about it. Whatever decisions they make are going to have a tremendous influence on whether shareholders can wait patiently for this stock to recover.

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The Quarter That Was
All things considered, Sanofi had an okay quarter. Revenue dropped a bit more than 1% on a constant-currency basis, which was a fair bit better than analysts had expected. What should trouble investors, though, was that there wasn't a lot of encouraging news in the details. The company's diabetes business is doing well, up more than 10% this quarter, but that is pretty much it. The company's other major drugs - Lovenox, Plavix and Taxotere - are either in decline or soon to be, and there is nothing else that really seems to be ramping up to offset this.

Although the top-line outlook is glum, the company's profitability is in solid shape. Margins have held up nicely and the company reported 2% quarterly growth in (constant currency basis) business operating income. I would expect that profitability should continue to hold up - the company can pull levers like salesforce layoffs to compensate for the impact of generics on the revenue line.

Is Genzyme The Answer?
It is pretty much a given in the financial press that Sanofi is going to do a deal, and the speculation is red-hot that the target is going to be Genzyme (Nasdaq:GENZ). That deal looks like a mixed bag to me.

Although Genzyme has a good standalone business in orphan drugs and enzyme replacement, a specialty market that is not unlike Sanofi's diabetes franchise in some respects, Shire (Nasdaq:SHPGY) has been eating away at that. Moreover, although Genzyme does have some promising late-stage drugs (Campath for multiple scelerois and mipomersen for cholesterol), I am worried about competition in the MS space and the safety profile of mipomersen. I think that mipomersen could be a good drug for Genzyme and the drug's originator, Isis Pharmaceuticals (Nasdaq:ISIS), but those safety issues should not be ignored given the FDA's gun-shy position on risk-benefit these days.

All of that being said, and including the fact that Genzyme has serious manufacturing issues right now, a deal could still make some sense. As long as Sanofi does not pay much beyond the low $70's, it should be accretive.

Still, "okay" should not be Sanofi's goal. I would personally lean more towards deals with companies like Gilead (Nasdaq:GILD), Biogen Idec (Nasdaq:BIIB), or maybe collecting a few smaller companies like Human Genome Sciences (Nasdaq:HGSI), Alexion (Nasdaq:ALXN) and Incyte (Nasdaq:INCY). But, again, if Genzyme ultimately gets approval for Campath and mipomersen, the stock is probably worth something north of the high $80's. So that would be good value for the money.

The Bottom Line
Sanofi has flaws. There are just no two ways about that. The company is going to see serious sales erosion from generics and the company's late-stage clinical pipeline does not inspire me to great enthusiasm. Still, like Novo Nordisk (NYSE:NVO), Sanofi has a great diabetes franchise and (unlike Novo) a great vaccine business as well. On top of that, the valuation is undemanding to the point where the company need only find a way to squeak out 2% free cash flow growth each year to be worth considerably more than today's prices.

Given the seeming certainty that Sanofi is going to take some bold moves to recharge the growth prospects, I think this is a value-priced turnaround opportunity. You have to have patience for this to work out, but I think the down-side risk here is really quite small. (To learn more, see Measuring The Medicine Makers).

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