Is This a Good Deal for Novartis AG and GlaxoSmithKline plc?

This seems to be a week for Big Pharma to do big things, and Novartis (NYSE: NVS  ) and GlaxoSmithKline (NYSE: GSK  ) are certainly doing their part. The two companies announced a series of transactions that seem to offer "win-win" opportunities to clean up and consolidate some non-core operations for both companies. Though it seems like Glaxo is getting the better deal, there's arguably less risk to the Novartis side of the transactions.

A pharma swap-meet
Novartis and Glaxo both found themselves with sub-scale businesses that didn't really fit into their long-term plans, and so they have chosen to work together on a series of transactions that will reshape both businesses.

Novartis is selling its money-losing vaccines business to Glaxo for $5.25 billion and up to $1.8 billion in milestones. Glaxo will also owe Novartis a 10% royalty on the sale of particular vaccines (including MenABCWY, Bexsero, and group B strep). This deal does not include Novartis' flu vaccine business, which is still for sale.

Novartis and Glaxo also agreed to merge their consumer OTC businesses in the form of a joint venture. Glaxo will own 63.5% of this JV, while Novartis will have the right to exit in three years (either entirely or in installments).

Last and not least, Novartis will acquire Glaxo's oncology portfolio and related R&D assets for $14.5 billion and up to $1.5 billion in milestones. This transaction includes approved drugs like Arzerra and Tykerb, as well as Glaxo's development-stage AKT inhibitor. Novartis will also have the right to opt in to partner on future Glaxo oncology drugs.

Not to be left out, Lilly (NYSE: LLY  ) is also involved in Novartis' spring cleaning. Lilly will be acquiring Novartis's animal health business for $5.4 billion. There had been rumors of Lilly's interest, and while this acquisition won't vault Lilly to the top of the animal health business, it will put it strongly in that second tier behind market leader Zoetis with mid-teens share comparable to Merck and Sanofi. Here too, then, Novartis is getting out of a sub-scale business and getting reasonable value for it (roughly 5x sales).

Can Glaxo do better with vaccines?
Novartis has long struggled with its vaccine business, a business that generated less than $1 billion in revenue and less than 2% of Novartis's total sales in 2013. A loss-making business, it was sub-scale and likely to remain so given competition from Glaxo, Pfizer, and Sanofi. In Glaxo's hands, though, it can be worth more. Glaxo's vaccine business is five times larger and is profitable. To the extent that products like Bexsero can be maximized, Glaxo is a good candidate to do it.

A JV leaves OTC upside
Novartis had identified its consumer health business as a target for action. Not unlike the vaccine business, this was a sub-scale operation as the segment produced less than 10% of the Novartis's revenue and a much lower percentage of profits. In combination with Glaxo's consumer health business, though, this is a $10 billion/year force to be reckoned with and a business with attractive scale and growth potential. With this deal structure, Novartis gets to participate in future upside and enjoy the benefits of a considerable scaled-up enterprise.

Paying a steep price for oncology assets
The most curious part of the Novartis-Glaxo transactions is the potentially $16 billion that Novartis is paying for Glaxo's oncology assets. Glaxo's oncology business was mostly just an "OK" business – Vortient, Promacta, and Arzerra all showed good growth in 2013, but none are really on their way to becoming a true blockbuster and this was more of a collection of good supporting actors than real stars. What's more, Glaxo's oncology pipeline is not that exciting. The company bet a lot on its failed MAGE-A3 vaccine and doesn't have much in the pipeline right now, including no particularly interesting immunotherapy assets.

In Novartis' hands, the company might be able to generate better margins and returns from the sale of Votrient, et al largely just through better sales leverage (adding existing products to existing sales reps). Even so, at close to 10x sales Novartis is paying a lot for the incremental revenue and profit potential. As for the opt-in rights, Glaxo's remaining pipeline is a collection of a half-dozen phase 1 programs and it is unclear if the company will develop these further.

For Glaxo's part, this is a good opportunity to monetize a business that was going to require major R&D investments to truly join the big leagues. With Novartis buying the existing business, Glaxo can concentrate its energies on areas where it has meaningful leadership – including respiratory care, vaccines, HIV, and consumer health.

The bottom line
I reject the notion that every deal has to have a winner and a loser. On balance, I think Glaxo is getting the best of these transactions, as the deal adds scale in vaccines, augments the consumer health business, and maximizes the value of a me-too oncology franchise. For Novartis, though, it is an opportunity to get value for a money-losing vaccine business, maximize the value of a sub-scale animal health business, upgrade its consumer health exposure, and profitably add scale in oncology with virtually no clinical risk. Even Lilly wins, as this was the most cost-effective option for adding scale. All told, then, each of the major players walks away with something they needed and wanted.

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Stephen D.

I'm an ex-Wall Street sell-side and buy-side analyst who has spent most of the last 10 years writing on a wide range of industries and investment ideas.

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