Powerful logic of the Ciba/Sandoz merger

21 March 1996 00:00  [Source: ICIS news]

Sandoz and Ciba have grasped the unique opportunity to combine their healthcare and agrochemical businesses. There is a powerful logic behind the merger. It will bring new strengths in key therapeutic areas in healthcare and allow significant resources to be devoted to pharmaceuticals research and development (R&D). The new company, Novartis, will be the world's leading agrochemicals producer and be a strong force in the growing field of nutrition. Shareholders will benefit additionally as the new group moves away from chemicals.

The second Basel marriage certainly completely changes the competitive landscape in pharmaceuticals. Novartis vaults to second place in the global pharmaceuticals rankings with sales of SFr14,000 million ($12,000 million) behind Merck & Co and ahead of Glaxo Wellcome. The company claims that research potential is unprecedented. The research budget of $1700 million compares with the 1994/95 spending at Glaxo Wellcome of $1900 million and the $1500 million of healthcare research spending at Pfizer, and is supplemented by what is claimed to be a unique, worldwide biotechnology network.

An 'almost perfect fit' across the drugs portfolio

The market share of 4.4% gives some idea of just how fragmented the pharmaceuticals business is. The complementarity of the product portfolio is, however, more important than overall percentages such as this. The prime movers of Novartis make the valid point that it is more important to be a leader in particular markets than have a higher market share overall and add that there is an obvious almost perfect fit across 90% of the healthcare portfolio.

Novartis will be particularly strong in oncology, cardiovascular medicines and central nervous system drugs but have products in seven distinct therapeutic areas. The top 10 products are expected to grow strongly with most achieving double digit growth over the next few years. Healthcare will account for 42% of sales of the newly merged company but after the spin off of chemicals in approximately 12 months time this proportion will rise to 69%.

Gaining critical mass in self medication

The new company will also achieve critical mass in self medication and rise to something like seventh place in the world ranking by sales. There will be a solid platform in the US and in Europe and the opportunity to boost current sales of $1300 million by rapid growth in Asia. Nutrition, with sales of $3200 million, will be considerably enhanced by the merger.

Novartis will be particularly strong in the agribusiness sector where it will be the front runner in crop protection chemicals and number two in both seeds and animal health. Global leadership is expected in four key areas - weed, disease and insect control and seed treatment - with sales of $4300 million. The company will have the largest crop protection R&D budget in the world with a focus on environmentally compatible and biological products. There are 15 new compounds in an advanced stage of development.

Strong growth from animal health

Seed sales of $950 million are likely to be enhanced by the broad investment in breeding and geographical expansion in eastern Europe and the Far East. Strong growth is expected from animal health (sales of $780 million) following the success of a systemic flea treatment product now being introduced in 30 countries. This sector particularly expects to benefit from the research synergies with pharmaceuticals and crop protection.

Research synergies

Key to the merger is the step away from chemicals and construction products and the focus on the life sciences, a move which will be welcomed by the investment community. The speciality chemicals division of Ciba, which comprises textile dyes, chemicals, additives, pigments and polymers will be demerged within 12 months and the construction chemicals business of Sandoz, called Master Building Technologies or MBT, will be demerged or sold. Combined sales of speciality chemicals, MBT, Mettler-Toledo and composites in 1995 were $8700 million.

Financial logic of Swiss merger

This demerger and sale add further financial logic to the alliance which sees the partners in the new company gain considerably in market share without having to resort to taking on a crippling debt burden. This had become one of the visions of Ciba chairman, Dr Alex Krauer, who last year commented that the best companies were prohibitively expensive and that mergers represented the way forward. A Swiss merger also provides the scope for both companies to respond to the wave of consolidation activity sweeping through the pharmaceutical industry without compromising their domestic allegiances.

The transaction is structured as a merger of equals and the exchange of shares will give Sandoz and Ciba shareholders 55% and 45% respectively of shares in the new company. The transaction will be tax free, the strengths of the individual balance sheets will be maintained and the existing companies will be absorbed in the new legal entity. The bonus to shareholders of both companies is considerable - the rise in market capitalisation of the two companies immediately after the merger announcement indicates just how much value can be released by deals such as this.

Combined group's strong financial position

Also, as the debt rating agency Standard & Poor's has pointed out, conservative financing of the deal does not impair the combined group's strong financial position in contrast to most other recent major mergers in the industry. Novartis will have less debt than cash so it will be able to strengthen the portfolio further over the next few years without having to deleverage considerably. In such circumstances, management expects to be better able to shape its own competitive environment.

The merger will accelerate growth but there will be the need for further tuning of the portfolio. Nevertheless, the deal is even more attractive when it is realised that Novartis will set off from a standing start with upwards of $13,000 million in cash and securities in its coffers. Also, it is clear that the portfolio will be driven hard. As it stands, the partners expect to achieve cost savings of $1600 million within three years of approval and 50% of that within the first 18 months. Pro-forma 1995 sales are put at $31,000 million and operating profits $5000 million with a return on sales of 16.0%. The 1995 net income is reported as $3600 million.

Difficult part yet to come

The first stages of the merger, from concept to board approval, have been accomplished rapidly but now the really difficult part of the process begins. An integration team has begun to analyse how the two companies can best be brought together but theirs has to be a somewhat thankless task. The success of this integration is essential. On their own, Ciba and Sandoz were looking to growth rates of between 11% and 12% a year over the next few years. Novartis can expect a growth rate of something more like 16%.

Novartis could grow at 16% per annum

The integration process is also sure to highlight areas where further cost savings can be made - the current cost target is something like 9% of the cost base of the new company. Cost reductions at firms like Glaxo Wellcome and Upjohn Pharmacia have been set at something more like 12% so it will be interesting to see whether Novartis believes it can gain any more as the analyses progress.

The cultural imperative

The implementation of these processes and the development of a Novartis corporate culture will be all important when it comes to achieving the synergy and growth desired by the two companies. Ciba and Sandoz are very different companies and there is nothing to say that they will sit easily together. The senior positions in the new company have been decided upon, and have been evenly split which is a good first step, but there is always a danger of a clash of ideas and of personalities not just at the top. Handling the 'people' side of the merger will be the most difficult part of the whole process.

Dr Krauer, who is 64 years old, will be chairman of the board of the new company and he will be joined by 43 year old Dr Daniel Vasella, currently head of Sandoz' pharmaceuticals division, as president. Dr Vasella, a hospital administrator until he joined Sandoz in 1988, will lead the corporate executive committee which will comprise the four sector heads and the heads of the corporate service functions. Mr Hermann Vodicka will be chief executive officer and Mr Rolf Meyer chairman of the new speciality chemicals group.

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