The asset-swap between GlaxoSmithKline (NYSE: GSK) and Novartis (NYSE: NVS) will lead to stronger focus by both companies on their current core activities. The transaction sets a new framework for future complex deals, where participants enhance their operations by divesting from non-profitable divisions, while acquiring assets that enhance the current portfolios. GSK’s position in vaccines will be magnified by acquisition of Novartis’s vaccines business, while Novartis boosts its cancer drugs division.

Industry Overview

GSK, based in the United Kingdom, is one of the biggest pharmaceutical companies in the world, currently employing almost 100,000 people and has a market capitalization of around $115bn. Its shares are trading at the present date at $46.71. After a downturn during the crisis years, the price has been steadily rising until 2014. Over this year it has been stable at, on average, $9 lower than its peak in 2013.
Swiss based Novartis is the second largest pharmaceutical company in the world (after Johnson&Johnson). It also employs around 100,000 people and its market capitalization is at $258.5bn. Currently it trades at $95.66. There is a clear overall post-crisis uptrend still observable today.
Both companies have been consistently profitable with strong positive free cash flows over the last decade, but while Novartis has been able to almost double its net income from 2004 to 2014, GSK has seen its figure remain almost flat over the same time frame. The deal under analysis in this report is driven by the aim of both companies to divest the most unprofitable divisions. At the same time they will focus more financial and human resources on the development and strengthening of their core activities in order to protect their respective competitive advantages (Oncology for Novartis, Vaccines for GSK, while both of them will still cover Consumer Healthcare).

Timeline

Given the complexity of the deal structure, there is a lot of time needed to prepare for the deal. The deal was first officially announced on 22nd April and expected to be completed by mid-2015. However, it is subjected to regulatory approval constraints. The exact timeline of the deal is as follows:
– 22nd April 2014:
GlaxoSmithKline issues a press release announcing a major 3-part inter-conditional transaction with Novartis involving Consumer Healthcare, Vaccines, and Oncology businesses.
– 18th December 2014:
General Meeting to seek GSK shareholder approval for the transaction.Approval is expected for the end of Q4 2014.
– H1 2015:
All regulatory approvals are expected to be obtained.
– End H1 2015:
Transaction is expected to be completed.
Completion is subject to the following constraints:
GSK shareholder approval
Regulatory approvals
Standard closing conditions
– By 2017:
All growth opportunities and projected cost savings are expected to be delivered.

Transaction Drivers

The Novartis-Glaxo transactions represent the new style of deal-making, allowing companies to build up their improvements on each other strengths, while eliminating small noncompetitive businesses. Since former chairman Daniel Vasella left Novartis last year, Chief Executive Joe Jimenez has made clear his willingness to reshape Novartis structure by focusing on sectors, in which it can compete on a global scale, rather than keeping a small and inefficient presence in a host of markets. Therefore, the company has been reviewing its businesses and sold a diagnostics division to Spanish Grifols SA last year. The deals with Glaxo, and a separate deal by Novartis to sell its animal-health business to Eli Lilly & Co. for about $5.4bn, accomplish that goal, focusing Novartis on pharmaceuticals, eye care, and generics.
By acquiring Glaxo’s oncology unit for around $14.5bn, Novartis will build up its already strong pipeline of cancer products. Roughly a fifth of its nearly $54bn in estimated annual revenue will come from cancer drugs. On the other hand, Glaxo will be focusing its business on respiratory, HIV, vaccines, and consumer health products. Those four areas will account for roughly 70% of the British company’s total sales. Moreover, back-office and selling costs are less burdensome when spread across more drugs. Focus on fewer product areas might make research spending more fruitful, providing the companies do not let go many scientists. Mr. Jimenez declared the deal “transformational” and said it would strengthen the company’s position in the high-value, but fiercely competitive, market for cancer drugs, where it is number two to Swiss rival Roche, while GSK cements a stronger position in the vaccines business. Indeed, opportunities to build greater scale and combine high quality assets in vaccines and consumer healthcare are scarce. By carrying out this transaction both companies can benefit from their core businesses and create significant new options to increase value for shareholders.
Finally, by exiting the vaccines and animal health markets, Mr. Jimenez is reversing part of the expansion pursued by his predecessor, Daniel Vasella. “Diversity is still important but this will allow us to focus on businesses where we hold a leading position,” he told the FT referring to the group’s three remaining core units: pharmaceuticals, eye care, and generic drugs.

Terms and Structure

– Novartis acquisition of GSK Oncology products
GSK oncology products would be acquired by Novartis for a $14.5bn payment and up to $1.5 billion development milestone contingent to be made on closing. Unless the milestone is not met before closing, GSK will reimburse Novartis the amount. Under the terms of the transaction, Novartis would have opt-in rights to GSK’s current and future oncology R&D pipeline.
– GSK acquisition of Novartis of Vaccines
Novartis has agreed to divest its Vaccines business to GSK for $7.1bn plus royalties.
– Combination of Novartis OTC with GSK Consumer Healthcare in a joint venture
The two companies have agreed upon creating a world-leading consumer healthcare business through a joint venture between Novartis OTC and GSK Consumer Healthcare. Upon completion, GSK will have majority control with an equity interest of 63.5% and will have seven of eleven seats on the joint venture’s Board.
– Novartis Animal Health Division divested to Lilly
In a separate transaction, Eli Lilly and Novartis have agreed to create a leading animal health business by divesting Novartis Animal Health Division to Lilly for a $5.4bn.
It is to be remarked that at present the elements of the transaction with GSK are still inter-conditional and subject to approval by GSK shareholders. All transactions are subject to closing conditions, including anti-trust approvals. Eli Lilly’ transaction is expected to close by the end of the first quarter of 2015 while Novartis transaction with GSK is expected to close during the first half of 2015.
BofA Merrill Lynch advised Lilly, while Goldman Sachs advised Novartis on the animal health deal. Lazard and Zaoui & Co. were acting as joint financial advisers for GSK.

To contact the authors of this story:

Peter Valach                                   peter.valach.mail@gmail.com

Alexandra Heidemann                     alexandra.heidemann@myebs.de

Riccardo Zanasi                             riccardozanasi@libero.it

Federico Cattani                            federicocattani@outlook.it

Luca Papa                                     luca.papa@studbocconi.it