Novartis sells Roche stake for $20.7 billion

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INTRODUCTION

Novartis has agreed to sell 53.3 million (approximately 33%) Roche bearer shares in a bilateral transaction to Roche for a total consideration of USD 20.7 billion.

Novartis has been a shareholder of Roche since May, 2001 and currently holds 53.3 million bearer shares of Roche’s common stock, representing approximately 33% of aggregate outstanding bearer shares. Novartis acquired the stake between 2001 and 2003 for a total consideration of approximately USD 5 billion as a long-term financial investment which delivered significant, recurring earnings contribution and cumulative dividends in excess of USD 6 billion. Over the holding period of the stake, this resulted in an annualized return of 10.2 % in USD (and 6.6% in CHF). Today, Novartis does not consider the financial investment in Roche as part of its core business and therefore not a strategic asset.

Novartis will report a gain from the sale of the stake in income from associated companies of approximately USD 14 billion, which will be core adjusted. The transaction is subject to the approval by the shareholders of Roche, at the Extraordinary General Meeting (“EGM”) of Shareholders of Roche to be held on November 26, 2021.

Company Overview:

Novartis

Born in 1996 through a merger between Ciba-Geigy and Sandoz, Novartis International AG is one of the most important pharmaceutical companies worldwide, second by sales and twentieth by size. With headquarters in Basel, Switzerland and Cambridge, Massachusetts, its shares are traded both on the SIX Swiss Exchange as NOVN and on the NYSE as NVS.

The main segments of Novartis are:

  • Innovative Medicines: R&D, manufacturing and distribution of patented medicines
  • Sandoz: R&D, manufacturing and distribution of drugs not protected by third-party patents
  • Alcon: R&D, manufacturing and distribution of eye care products

The company’s most successful products are:

  • Cosentyx: utilized mainly to treat plaque psoriasis
  • Entresto: used to treat symptoms of heart failure

The company’s sales over the first nine months of 2021 have grown on average by 7% each quarter, however, the company managed to improve their profit margin by cutting off unnecessary expenses, this let them reach an average growth of 22% of net income. During the current year, the Swiss company has had great success in penetrating new markets, as shown by their 10.3% average growth of sales in those areas. The future growth drivers are:

  • The approval of Cosentyx and Entresto in key new markets such as China and Japan
  • Increase in requests for their best-selling pharmaceuticals

However, the company does not have an exciting outlook for next year; they expect the group sales overall to grow by low to mid-single digits.

Roche

Founded in 1986 and nowadays traded as a U.S.-dollar denominated American Depositary Receipt (“ADR”) on the OTCQX. Roche is a Swiss company whose business is mainly focused on pharmaceutical development and diagnostics. It’s one of the largest companies by pharmaceutical sales in 2021.

Roche is most known for bringing to the market drugs such as:

  • Perjeta: used to treat breast cancer ($3.7 billion in first 9 months of 2021)
  • Ocrevus: used to treat relapsing and primary progressive forms of multiple sclerosis ($3 billion in first 9 months of 2021))

In recent years the growth of Roche has been determined mainly by great automation of their processes, a skilled workforce and an extremely strong distribution network that the company built incredibly fast. This last aspect is extremely important for one of the factors that keep the Swiss enterprise competitive, the ability to enter and establish their brands in new markets. This is of great help for such a huge company, since when sales decline in established markets, they are balanced by the increase in new markets. This is what happened in 2022 for the pharmaceutical division, sales decreased in the US by 3% but they increased by 20% in Japan.

2020 has been a difficult year regarding sales growth, that have been stagnant and slightly declining from 2019. However, the company managed to improve their profit margin, commanding an increase in earnings of 5.9% despite a decrease in sales by 5.4%. For the first nine months of 2021, sales have been growing steadily, the company reported an increase in sales by 8% (CER) with an increase of almost $3 billion compared to the year 2020. The pharmaceutical division results were mostly stagnant, while for the Diagnostic division Roche reported an increase in sales of 39%, driven by key launches in the fields of virology and oncology.

This was mainly due to the development and distribution of the SARS-CoV-2 Rapid Antigen Test. Furthermore, the company raised its outlook for the rest of the year and for 2022. This was mainly due to two factors:

  • The forecast of a probable future increase in Covid variants and therefore an increased need for testing devices
  • A new all-time high in the number of new compounds in late-stage development (17)

Industry overview

The global pharmaceuticals market is rapidly growing and is expected to reach $1.7 trillion in 2025 at a CAGR of 8% from where it currently stands at $1.2 trillion. Apart from the role the Pharma industry has had in the COVID-19 situation, growth comes from companies rearranging their operations and from the aging population. The global population over 65 was 703 million in 2019 and the growth of the share of the population over 65 years old has increased from 8% in 2015 to 9% in 2019, according to the Population Reference Bureau. The increase in the average population age also translates into increased demand for medicine for chronic illnesses related to old age, such as arthritis, heart disease, diabetes and cancer.

Novartis seems to follow market trends of rearranging its operations and shifting its focus.  Big Pharma companies have been targeting higher-grossing drugs and disposing of assets such as consumer healthcare units. Novartis has announced in its 2021Q3 report that it has begun a strategic review of Sandoz, in line with what its Pharma peers are doing to focus on innovative drugs: GlaxoSmithKline’s over-the-counter products business were placed into a consumer health joint venture operated with Pfizer; Pfizer’s off-patent and generic drugs division is now part of Viatris, a new company formed by the merger of that business unit with Mylan; Merck’s legacy drugs, biosimilars, and women’s health products have been spun off into a new, publicly-traded company called Organon.

Moreover, the cash generated from the sale could also translate into an acquisition in line with the market tendencies, examples including the $9.7 billion buyout of The Medicines Company, developer of an RNA interference drug for high cholesterol; the $2.1 billion purchase of cancer radiotherapy developer Endocyte; and the $8.7 billion takeover of AveXis, which is now known as Novartis Gene Therapies.

Deal Rationale

The sale of 53.3 million Roche shares to Roche for a total consideration of USD20.7 billion monetise a 20-year investment of Novartis as a shareholder of Roche providing a $14 billion capital gain to be summed to the $6 billion in dividends received during the years.

The transaction is in line with Novartis’s strategic focus and the proceeds of the sale will be deployed consistently with the capital allocation priorities of the firm, by investing in the existing business, adding to the dividend, acquisitions and share buybacks. Novartis structure is further simplified by the deal after the Alcon spin-off and the launch of the generic-drug division of Sandoz. The deal will provide a cash windfall to further build on its strategy and develop its strategic objectives. The “Innovative Medicines” division, responsible for finding and developing higher-margin brandied prescription drugs, will benefit from additional resources coming from the sale.

The deal disentangles two of the major pharma competitors and removes ownership ties for Roche. In particular, it removes the strategic veto powers that Novartis had on Roche’s decisions and provides full strategic flexibility to the pharma company.

The deal is expected to be accretive, boosting Roche’s EPS by 7% according to Jefferies analysts, and stopping speculations about possible large acquisitions. No change in control will arise as the founding families’ shareholder pool already holds the majority of the votes, but they will only increase their voting power to 67.5%. Following the deal and the cancellation of the acquired shares the free float will increase from 16.6% to 24.9%.

Deal Structure:

On Thursday November 4th, 2021, Novartis announced it has agreed to sell 53.3 million (approximately 33%) Roche bearer shares in a bilateral transaction to Roche for a total consideration of $20.7 billion.

Novartis started building a stake in Roche back in May 2001 as a long-term financial investment when the Swiss activist investor Martin Ebner offered his Roche stake. By 2003, the company reached its current stake of 53.3 million bearer shares, representing 33% of the aggregate outstanding amount.

Novartis paid a total consideration of approximately $5 billion, which delivered significant, recurring earnings contribution and cumulative dividends in excess of $6 billion. Over the holding period of the stake, this resulted in an annualized return of 10.2 % in U.S. Dollars (and 6.6% in Swiss Francs).

The share buyback comes as Roche’s stock price on the SIX Swiss Exchange has been trading at all-time highs, on the back of its strong performance from Covid-19 products. The price per share agreed for the buyback is $388.99 (CHF 356.93), which reflects the volume-weighted average price of Roche’s non-voting equity certificates over the last 20 trading days ending in November 2nd, 2021. On the announcement day, Roche shares were up 2.4% by mid-morning, reaching an all-time high, while Novartis shares were up 0.2%.

Roche will use debt to finance what is called a “disentanglement of two competitors” and plans to reduce its capital by cancelling the repurchased 53.3 million shares to regain full strategic flexibility.

The transaction will not result in a change of control as the founding families already held most of the votes, but its voting power will increase to around 67.5% following the deal. Additionally, the free float will move from 16.6% to 24.9%.

The transaction will be completed after Roche shareholders’ approval, who will vote on the plan at an extraordinary general meeting on November 26th, 2021.

Authors: Riccardo Colombo, Daniele Rabusin, Alice Fanchin, Francesco Paganin, Alessandra Cinotti, Ioana Gavrilescu

Sources: medcitynews, researchandmarkets, biopharmadive, bloomberg, cnbc, biospace, novartis, reuters