Nice of You to Notice Novartis

The silent giant
If Novartis (NYSE:NVS) were a tree falling in the forest with nobody there to hear it, it apparently wouldn't make a sound. Until lately, anyway. Novartis has been strategically synchronized within its industry for some time with little attention from Wall Street. The company posted $28.2 billion in sales for 2004, making it No. 4 among its peers. The three companies outselling Novartis are Pfizer (NSYE: PFE), with yearly sales of $52.5 billion; Johnson & Johnson, with $47.3 billion; and GlaxoSmithKline (NYSE:GSK), with $39 billion.

The firm also ranks fourth in market capitalization, at $118.7 billion, and manages to maintain a healthy net profit margin of 20.4% -- a figure that beats Johnson & Johnson's 18.0% and compares favorably with best-in-class Merck's (NYSE:MRK) 26.8%.

A balanced portfolio
In many respects, Novartis is the Swiss Johnson & Johnson, given its more holistic approach at developing its businesses in the health-care industry. While many pharmaceuticals swing for the fence with the next blockbuster drug, Novartis is different. It still swings for the fence, but it doesn't ignore the value of a few good base hits.

Its strategy provides stable free cash flows from the likes of Gerber baby foods and a well-established set of nutrition-supplement products that it uses to fund its developments on the big drugs. As a result of $3.5 billion dedicated to new drugs, Novartis boasts a strong pipeline, with more than 75 projects in R&D and 31 of those in the final phase 3 trials. The Novartis pipeline has produced blockbusters such as Diovan, the worldwide leader among angiotensin receptor blocker (ARB) hypertension drugs, which produces more than $3 billion in annual sales. Other key Novartis drugs include Gleevec, a highly effective leukemia drug with promising future developments, and Lamisil, the world leader in fungal nail infections, producing more than $1 billion annually.

To brand or not to brand; why not both?
Novartis recently moved to acquire Hexal and Eon (NASDAQ:ELAB) in an $8.3 billion all-cash deal that will make Novartis the largest manufacturer of generic drugs in the world. With this news, the Street finally heard the tree fall -- shares were up nearly $2 to $50.90 upon the Feb. 22 announcement of the purchases. The acquisitions are significant, since U.S. regulators are pushing to reduce drug prices by exploring drug reimportation and giving earlier green lights to generic manufacturers for patented drugs. What's more, Novartis will add a heightened manufacturing competency in key markets -- Hexal in Europe, Eon in the United States.

Generic-drug makers survive by being the most efficient of the low-cost, high-capacity manufacturers. Novartis has taken a leap forward in developing its strategy to match a marketplace that favors the proficiencies of the generic-drug business. The company can still collect a premium on its newly developed drugs, and when the time comes to go generic, Novartis can simply roll that drug onto its generic-manufacturing line. Why eat the steak and toss a perfectly good bone?

The cash deal will allow Novartis to realize benefits without the burden of further debt. Not that the company can't handle more debt, though. The firm carries a debt-to-equity ratio of 0.20, compared with an industry average of 0.25. This affords Novartis room to assume more debt to fund deals like this one, or future ones, and remain comfortable relative to its peers. But did Novartis overpay for its current acquisition? It's difficult to say, since the synergies created by the acquisitions are impossible to measure at this point. The extent to which the company can realize synergistic benefits largely represents the inherent risk of these deals. On one hand, Novartis can reduce manufacturing costs company-wide, realize additional cash flows, and feed its generic line from its patented drug line. On the other hand, will it realize synergies that offset the price paid? Will it be able to balance the different business cultures? Will it be able to manipulate the traditional bidding process for drugs that lose patents? That all remains to be seen.

After the tree has fallen
Novartis is poised to enjoy profits on its innovations both pre- and post-patents. This is just one more feather in the cap for the management team as it secures its grip on an already-sound strategic position within its industry. The Street has now heard the tree, but will it continue to listen? Only a Fool would speculate on this question -- so here I go.

Novartis tends to maintain a sure but steady business approach. The company is more likely to shoot the easy, high-percentage layup as apposed to the 540-degree-behind-the-back slam dunk. As a result, it still scores points, but it doesn't always get the crowd on its feet. The company is more likely to pay attention to its long-term strategy than make its quarterly earnings to the penny. And its more-reserved European marketing approach goes less noticed here. This silent giant is therefore likely to slip off Wall Street's radar once again. But you can rest assured that some smart money and some industry watchers will be following Novartis intensely. The marriage of big pharma and generic drugs sets a new precedent that, if successful, could set a new industry standard.

Fool contributor Cliff Malings enjoys hiking in the White Mountains of New Hampshire with his faithful dog, Savannah, by his side. He owns shares of Novartis but no other company mentioned here. The Motley Fool has a disclosure policy.