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On Tuesday, Bloomberg reported that Novartis (NYSE: NVS ) , which has been contemplating the future of its animal health business, may not choose to sell it after all. Instead, an asset swap with big pharma peer Merck (NYSE: MRK ) might make more sense for the diversified drug maker, though the article made no mention of Merck's opinion in the matter. This interesting news rounds out a year of major pharmaceutical restructuring that saw Pfizer's spin off its own animal health business in the form of Zoetis (NYSE: ZTS ) .
What Novartis would get
Novartis has been considering shopping all of its non-branded human pharmaceutical divisions to focus more intently on areas of expertise. But a straight sale doesn't do much for Novartis, which already has a stellar cash position, with $5.6 billion in cash and equivalents and $14 billion in operating cash flow at the end of 2012. That's already enough to maintain a 3.2% dividend, share buybacks, and an estimated $4 billion to $6 billion in annual acquisitions moving forward.
Instead, Novartis would drop an animal health unit that saw only mid-single-digit growth for most of 2013, and pick up a respected over-the-counter business to supplement its own double-digit growth. It would add popular over-the-counter products like alergy pill Claritin and sunblock Coppertone to its portfolio.
What Merck would get
Merck, which has underperformed peers like Johnson & Johnson and Pfizer in 2013, could really use some dealmaking to boost its business efficiency in support of its upcoming pipeline of drugs. That pipeline includes exciting potential growth drivers like a BACE inhibitor for Alzheimer's Disease and a PD-1 inhibitor for various cancers that has received FDA Breakthrough Designation.
Merck has already sought to improve operating efficiency with layoffs and the sale of its ingredient-manufacturing business. Dropping its consumer care business would remove a segment whose sales declined 3% year over year in the first nine months of 2013. It would also pick up Novartis' animal health business to supplement its own stagnant business -- but that's not that exciting.
Merck's next potential move could be far more interesting. Merck could package up its own animal health business with Novartis's, cut out inefficiencies and emphasize synergies, and spin off the business to uncover its value. At a trailing P/EBITDA of 9.4, Merck could unlock as much as 50% in extra value if the reshaped business were comparable to Zoetis, which trades at a P/EBITDA of 13.5. That cashflow could offset waning sales of blockbuster Januvia and bolster its research efforts.
What Zoetis would get
Almost all of Zoetis' competitors are veterinary subsidiaries of larger pharmaceutical businesses. As the largest of the animal-health pure plays, Zoetis is in a prime position to profit in a global market for animal health care. But with seemingly every big pharma player looking to slice and dice corporate structures, there's always a risk that another pure play competitor will appear out of the blue. If rumors of a Novartis-Merck asset swap are true, Zoetis could face the challenge of competing with a new, reinvigorated animal health business.
The bottom line
The word "restructuring" can have positive and negative connotations. On one hand, it could mean that management is seeking answers for a struggling business. On the other hand, it could mean that management is optimistic about the core business and sees an opportunity to unlock the value of a secondary component to the business. Fellow Fool Leo Sun points out that that was the motivating factor behind Zoetis' spinoff. Selling or trading animal-health and consumer-care divisions could benefit Novartis, Merck, and their shareholders, but only if the companies can use those proceeds to execute their core pharmaceutical pipelines.
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