Can Novartis AG Maintain Its Momentum?

Novartis (NYSE: NVS  ) has done better over the past six months than I thought it would back in December of 2013, as investors have liked what they've seen with the company's restructuring efforts and surprisingly positive clinical data on heart failure drug candidate LCZ696. In the "what have you done for me lately?" world of Wall Street, though, I do wonder whether Novartis has enough potential catalysts in hand to keep up a level of enthusiasm that frankly seems outsized relative to the valuation.

LCZ696 could be a long-awaited answer
Not only has Novartis's drug LCZ696 passed through a successful Phase III trial (PARADIGM-HF), this heart failure trial was stopped early for efficacy. The trial was designed to determine whether the drug could reduce cardiovascular deaths and/or heart failure hospitilizations in patients with reduced ejection fractions.

This marks an all-too-rare success in heart failure, a disease that effects millions of people in the U.S. and EU but seldom responds to medication. With upwards of 13 million patients in Class II to Class IV heart failure in the U.S., EU, and Japan, this drug could generate sales in excess of $5 billion a year. Right now, patients with Class II to Class IV heart failure have few effective treatment options; cardiac resynchronization devices from Medtronic, Boston Scientific, and St. Jude Medical can help a limited number of patients, and a small number can also benefit from ventricular assist devices produced by Heartware and Thoratec.

Mitigating the success of LCZ696 to some extent is the disappointment over serelaxin. This other heart failure drug candidate produced iffy clinical data and an FDA panel voted unanimously (11-0) against approval. In the win-some/lose-some world of high-stakes drug development Novartis is likely coming out ahead on balance given the strong data on LCZ696.

Driving value from Glaxo's oncology business will be a challenge
In paying around 10x revenue, Novartis made a big bet that it can drive higher sales and margin synergies from the GlaxoSmithKline  (NYSE: GSK  ) oncology business. Votrient, Mekinist, and Tafinlar can certainly become blockbusters in the hands of Novartis, but given the price paid they pretty much have to be if Novartis is going to get value from this deal. Seeing as how so many companies are targeting the same indications with immuno-oncology (melanoma and renal cell carcinoma), though, competition could stunt the long-term potential of these compounds.

No such thing as a risk-free pipeline
Competition is fact of life for all Big Pharma companies, but the oncology assets acquired from Glaxo aren't the only area where Novartis could see unwelcome competition. Ultibro could well become a $2 billion-plus drug for COPD, but Boehringer Ingelheim and Glaxo are going to have something to say about that, particularly as Glaxo may end up with a time-to-market edge.

So too with secukinumab and LEE011. While secukinumab was the first non-TNF biologic (it's an IL-17 antibody) to show activity in ankylosing spondylitis, the performance in rheumatoid arthritis wasn't so special and the company is going to face ample competition from Johnson & Johnson, Lilly (NYSE: LLY  ) , and Amgen. With LEE011, this CDK 4/6 inhibitor has shown impressive early stage results, but the drug is behind Pfizer's palbociclib (and may face competition from Lilly's so far impressive CDK 4/6 drug bemaciclib) and it can be surprisingly difficult to carve into established market share in oncology. Novartis has been pretty quiet about this drug, though, and there's definitely a chance that more impressive pivotal trial results will swing sentiment in its favor.

With the deck reshuffled, Novartis "is what it is"
Novartis has been busy. The company bought Glaxo's oncology business and sold its vaccine business (to Glaxo), relieving itself of a money-losing business that lacked scale to maximize the potential of MenABCWY and Bexsero. The company also agreed to merge its consumer health business into a joint venture with Glaxo, creating a major player in the space. Last and not least, the company sold its animal health business to Lilly at a pretty healthy 5x sales multiple.

The issue is that Novartis is now back to a "now what?" story. Incremental updates on drugs in the pipeline like LEE101, CTL019, and BKM120 (a PI3K inhibitor) will certainly garner attention, as will Valeant's pursuit of Allergan and the potential that a completed deal makes Valeant's Bosch & Lomb a more formidable rival in ophthalmology and eye care. That said, core growth in the drug business is likely to bump along in the low single digits, with operating profit growth in the low to mid single digits, until LCZ696, Ultibro, and the oncology drugs make it to market and start generating revenue.

The bottom line
Even with unexpected success in heart failure, Novartis isn't looking at tremendous near-term growth and there will is now a high bar for the oncology business acquired from Glaxo. Moreover, all of Novartis's restructuring efforts thus far have led to a net cash outflow, not exactly supporting the buybacks that investors may have wanted. I underestimated just how much enthusiasm the market would have for Novartis's restructuring efforts, but I just don't see a lot of levers left to pull to drive a substantially higher price.

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