Will Nestle Succeed Where Others Have Failed?

By Stephen D. Simpson, CFA | May 23, 2011 AAA

A curious announcement came out this week when Swiss food and nutrition giant Nestle (OTC:NSRGY) announced that it was acquiring U.S.-based medical therapeutics and diagnostics company Prometheus Laboratories. Nestle will fold Prometheus into its newly formed Nestle Health Science division and likely will guide the company's efforts toward more research into nutrition-based therapeutics as well as areas like metabolism. Although Prometheus' $250 million or so in ongoing annual revenue will not make a major dent in Nestle, it is an interesting deal on multiple levels. (For background reading, see Investing In The Healthcare Sector.)

TUTORIAL: Stock Basics

What Nestle Is Getting
In acquiring Prometheus, Nestle is getting a business that has focused on diagnostics and therapeutics for indications in gastroenterology and oncology. Prometheus recently got approval to sell a Crohn's diagnostic test, and the company sells a variety of drugs for conditions like cancer and irritable bowel disease.

Nestle did not specify the price it is paying for Prometheus. Considering others deals like Novartis' (NYSE:NVS) acquisition of Genoptix, Quest's (NYSE:DGX) acquisition of Celera, and Thermo Fisher's (NYSE:TMO) acquisition of Phadia, Nestle likely paid at least $650 million, but that is purely speculation at this point.

Going Where Others Have Failed Before?
It may be premature to suggest that Prometheus is the first step in a headlong jump into pharmaceuticals and diagnostics, but it is a notion worth considering. It is relatively unusual for a consumer products company to expand into pharmaceuticals and diagnostics, and the record here is mixed. (For more, see Healthcare Sector: Play Or Stay Away?)

DuPont (NYSE:DD) had some success in pharmaceuticals (including near-blockbusters Hyzaar and Cozaar) before deciding that the cost and complications of clinical development, FDA approval, and pharmaceutical marketing outweighed the profits to be made. Procter & Gamble (NYSE:PG) likewise had visions of pairing a branded drug business with its consumer products franchises and likewise found that it was more trouble than it was worth. P&G later sold its drug business to Warner Chilcott (Nasdaq:WCRX).

The drug business can be enticing. There's limited competition (and the FDA approval process means that nobody sneaks into the market), ample reimbursement, rich pricing, and a need for clinical data. After all, a company cannot sell a branded drug without some proof it works - unlike the packaged food business where very little ever has to be proved.

At the same time, the drug business demands beastly expensive R&D, long development time lines, and extensive clinical proof of efficacy and safety. Unlike packaged foods, where a product launch is based largely on whether tasting panels like the product and the company believes it can market it profitably, the FDA is the ultimate arbiter of whether a branded drug can be sold in the U.S.

Mixing Food and Drugs
Another interesting angle to this move is the blurring line between food, medicine and nutrition. Abbott Labs (NYSE:ABT), for instance, is just one healthcare company that also markets a line of over-the-counter food/nutrition products. Moreover, while many companies like Herbalife (NYSE:HLF) and GNC (NYSE:GNC) sell supplements with vague nutritional claims, drug companies like GlaxoSmithKline (NYSE:GSK) have taken the next step and pursued clinical trials and FDA approval for modified nutritional supplements.

With all that in mind, there are multiple directions Nestle can go with this deal. Prometheus may give Nestle new sales avenues for its existing nutrition business (one of the largest in the world). It may also be the case that Nestle can leverage Prometheus' science and resources to develop new "neutraceuticals", perhaps even some that would merit full-blown clinical development through the FDA approval process.

The Bottom Line
Only time will tell whether acquiring Prometheus is just a means for Nestle to expand its nutrition sales channels, an entry into the pharmaceutical and diagnostics markets, or a mistaken attempt at diversification. However, if it's successful, it raises the interesting possibility that other food companies like Kellogg (NYSE:K) or Kraft (NYSE:KFT) will look to the medicine cabinet as a future avenue to growth. (For more, see A Checklist For Successful Medical Technology Investment.)

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