Acquisitions to Put Sandoz at Top of the Generics Heap

28 February 2005 00:01  [Source: ICB Americas]

In a deal that could set off a new wave of M&A activity in the generic drug industry, Novartis will pay roughly $8.5 billion to capture Lake Success, N.Y.-based Eon Labs Inc. and Holzkirchen, Germany-based Hexal AG. The acquisitions will catapult Sandoz, the generic arm of Novartis, into the top slot of the fiercely competitive global generics market.

Novartis will shell out €5.65 billion ($7.5 billion) in cash for Hexal, the second-largest generic firm in Germany, and Hexal’s 67.7 percent share of Eon Labs, which has a strategic partnership with Hexal. Once the merger is

approved by the Eon board, Novartis will launch an additional tender offer to acquire the remaining 31.9 million shares of Eon for $31 per share, or about $988 million.

Sandoz expects to realize $200 million in cost savings within the first three years of closing the deal, with half of that figure achieved in the first 18 months. The deal is expected to close in the second half of 2005.

The deal knocks Teva Pharmaceuticals Inc. out of the leading position in the global generic drug market. The additions will also shift Sandoz into the top position in Germany and the number-two position in the US, considered critical markets in the generic drug arena.

“We will be building a generics powerhouse in the next few months,” Andreas Rummelt, CEO of Sandoz, told investors in a conference call following the announcement. “The strongest brand names are coming together.”

The two businesses bring different strengths to Sandoz’s operations, though both contribute to the company’s goal of becoming increasingly vertically integrated and global in reach. Hexal, though more of a commoditized player, significant bolsters Sandoz’s presence in the European market, particularly in Germany, where there is strong generic pricing.

“Sandoz previously had a very small share of the lucrative German market (2 percent of the 2003 market according to Datamonitor estimates), while Hexal held a substantial 20 percent,” says David Evans, associate analyst, pharma vitae and commercial development, with Datamonitor’s healthcare & pharmaceuticals business unit. “Hexal has proven capabilities in rapid product development and registration, fitting with Sandoz’s focus on being first to market.”

Meanwhile, Eon brings robust growth—boasting a CAGR of 36 percent between 1997 and 2004—and expertise in “difficult-to-make” generic products. “Eon Labs … has succeeded in going into niches and areas where there are few competitors and [where] technologies are not easily copied—their operating margin of 40 percent reflects that,” says Daniel Vasella, chairman and CEO of Novartis.

Novartis sees sales in the global generics market pushing up from $58 billion in 2004, to roughly $100 billion by 2010. “We should have a significant share of the overall worldwide market,” says Dr. Vasella, who adds that capturing about 10 percent of the market by 2010 “should be a target that is absolutely within reach.”

The two acquisitions are a good launching pad for achieving that goal. Combined pro forma 2004 sales of the new Sandoz totalled $5.1 billion, and the company’s expanded portfolio will boast over 600 active ingredients in more than 5,000 dosage forms.

Importantly, the addition of Hexal and Eon will add scale that can help the company better penetrate physician and pharmacist markets as it prepares to launch 70 drugs, 37 coming from Hexal and Eon, in the US and Germany alone in 2005.

Leading brands in the newly expanded portfolio include citalopram (Forest Laboratories’ Celexa), omeprazole (AstraZeneca’s Prilosec), simvastatin (Merck’s Zocor), buproprion (GlaxoSmithKline’s Wellbutrin) and enalapril (Merck’s Vasotec).

The deal also reinforces Sandoz’s global production network, which consists of 43 plants spanning 22 countries, and encompasses technologies ranging from tablet production to production of sterile injectables and asthma inhalants. Specifically, Hexal deepens the company’s manufacturing footprint in the European market, while Eon adds two facilities in the US.

Importantly, the company will have significant in-house manufacturing capacity across the globe for active pharmaceutical ingredients, “which often is key to be first to market, but usually is mandatory to be last to market in terms of cost,” says Mr. Rummelt.

The global generics market is growing at a healthy clip. However, severe pricing pressure has pressured margins and created a highly competitive environment. Novartis expects to leverage its heft to lower production, sourcing and processing costs, which should improve its competitiveness across the life cycle of a generics product.

“We have not started to address the initiative to really globalize several of our functions, like production, registration and development. With this acquisition, we will have further leverage to do so more deeply and more rapidly” says Dr. Vasella.

Though analysts acknowledge the importance of global reach and a broad product and technology portfolio, there are also concerns that Sandoz has grown too big, too fast.

“Questions have been raised in the past over Sandoz’s future with Novartis, and its performance has continued to disappoint,” says Datamonitor. In the absence of any major acquisitions, Sandoz would have posted weak 2004 results, affected by price competition.

In fact, Hexal’s leading position in Germany may be at risk once it is folded into Sandoz’s operations. Branded generics lead the pack in Germany, and Hexal’s intrinsic value may be compromised once it is integrated into Sandoz, says Datamonitor.

“German healthcare reforms are now putting severe pressure on generic pricing, which is stunting growth prospects for leading players,” says Mr. Evans. Generics have already achieved 50 percent penetration in the German market, meaning any growth will come from new product launches. “Therefore, while Hexal’s generic profitability is currently very good, the economic environment is not particularly favoring sustained growth.”

The acquisition of Hexal and Eon Labs is the latest in a string of generics purchases for Novartis, which clearly has had Teva’s number one slot in its crosshairs.

“The financial muscle of Novartis has given Sandoz unprecedented purchasing power within the generics industry, allowing the Swiss firm to fulfill its vision of Sandoz as a truly global organization” says Datamonitor.

Last summer, the company picked up Quebec, Canada-based Sabex Holdings Ltd., which specializes in injectable generics. In 2002, Novartis paid roughly $850 million to acquire the Slovenian drug firm Lek D.D., giving the company a foothold in the rapidly growing Eastern European generics market.

Earlier bolt-on acquisitions included the US generics business operations of Apothecon Inc., BASF’s European generic activities, Argentinean generic firm Labinca SA, and the UK-based Lagap Pharmaceuticals Ltd.

The purchase of Hexal and Eon could set the stage for a new wave of M&A activity in the generic drug sector.

“Economies of scale are extremely important within commodity generics, and further consolidation, especially within the fragmented European markets, is certain to follow,” says Datamonitor.

German companies are ripe for the picking, following Novartis’ bold move. “There are a host of regional players that could make targets for companies wishing to step up their German presence: the likes of BetaPharm, Fresenius, NeuraxPharm, West Johann Lohmann, Woerwag and ABZ Pharma,” says Mr. Evans.

He notes that players with strong technology platforms will also continue to be attractive targets. These include companies with expertise in transdermal and inhalable delivery systems, and even biogeneric developers.

“Datamonitor also expects consolidation in the immature, fragmented generics markets in France, Spain and Italy, which all offer strong growth prospects in generic utilization. Teva’s acquisition of Pfizer’s Dorom unit in Italy typifies this,” adds Mr. Evans.

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