Novartis Building Itself Into A One-Stop Shop

By Stephen D. Simpson, CFA | January 26, 2011 AAA

Monday's announcement that Novartis (NYSE:NVS) will acquire Genoptix (Nasdaq:GXDX) offers an interesting lesson in how quickly things can change in the medical technology market. It was not so long ago that Genoptix was a hot idea and analysts treated it as an example of how the practice and business of medicine was changing. At that same time, Novartis was seen as a sluggish pharmaceutical company and a lagging part of the old guard.

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More recently, though, Genoptix appeared to have hit a wall in its near-term growth and management seemed to have a nearly empty bag of tricks to change that. Novartis, though, has remade the investment community's vision of the company, with more credit being given to its attractive pipeline and growing generics business. To that end, Monday's deal gives Genoptix shareholders a decent exit strategy, while giving Novartis yet another growth option for the future. (For more, see The Latest Greatest Corporate Mergers And Acquisitions.)

The Terms of the Deal
Novartis announced that it will acquire Genoptix for $25 in cash, a 27% premium to Friday's price, but still a relative bargain on an EV/revenue or EV/EBITDA basis. Even acknowledging the low apparent valuation ratios on the deal, the terms were in line with the recent General Electric (NYSE:GE) acquisition of Clarient (a similar business) and reasonable relative to Genoptix's own near-term growth outlook. (For more, see Investment Valuation Ratios: Enterprise Value Multiple.)

What Novartis Is Getting
Genoptix is a specialized lab services provider that targets community-based oncologists and hematologists with its specialized diagnostic services in leukemias and lymphomas. In very simple terms, an oncologist will send a patient sample to Genoptix, who will perform a variety of advanced tests on it to determine whether the sample is cancerous (and if so, what type).

The business model is supposed to be something of a win-win for both parties. Community doctors do not have the resources (or the patient population) to justify the cost of advanced diagnostic equipment, nor the personnel to operate them. Moreover, Genoptix offers a more "hands on" customer service model that large reference labs like LabCorp (NYSE:LH) and Quest Diagnostics (NYSE:DGX) often find difficult (or too expensive) to match.

Unfortunately for Genoptix, the company had hit something of a wall. Although the company had about 10% of the bone marrow testing market and a customer base of over 1,300 oncologists, management seemed hard-pressed to find ways for the company to grow, and there was always the overhanging threat of more focused competition from LabCorp, Quest or Bio-Reference Laboratories (Nasdaq:BRLI).

Where Does Novartis Go Next?
In some respects, this could be a challenging deal for Novartis. Although there is more of a "high touch" sales aspect to pharmaceutical sales than many people realize, Genoptix nevertheless operates according to a much different model than the rest of Novartis's business. By the same token, it could be just one step in Novartis building a much larger and more comprehensive diagnostics enterprise. (For more, see A Checklist For Successful Medical Technology Investment.)

Diagnostics is arguably the only large high-growth/high-margin healthcare market where Novartis does not have much presence, and this deal could be the beginning of a bigger push. In buying Genoptix, Novartis is, at a minimum, acquiring state-of-the-art facilities and equipment, as well as highly trained technicians.

All of that could be leveraged with a larger suite of testing capabilities (either acquired or developed internally). There could be a natural synergy between cancer testing and a developer of cancer drugs - particularly as there seems to be an inexorable trend toward drugs that require advanced testing to identify those patients who will respond best. Although that thesis does not really argue for Novartis getting involved in the bidding for Beckman Coulter (NYSE:BEC), for instance, it could mean that Novartis is more of a player in molecular diagnostics deals in the future.

The Bottom Line
Novartis has not always been a company that has enjoyed the benefit of the doubt when it comes to Wall Street respecting or valuing the company's moves and strategies. Nevertheless, the stock still seems to be attractively priced, and the company offers investors a good growth outlook and one of the best pipelines among European biotechs without some of the risks that are bedeviling Sanofi-Aventis (NYSE:SNY), AstraZeneca (NYSE:AZN) or Roche (Nasdaq:RHHBY). Novartis has a long way to go before becoming any sort of diagnostics titan, but investors should be encouraged that management is looking at multiple avenues to continue growing the business. (For more, see Where The M&A Action Is, And What's Next.)

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