Novartis AG’ vision has gone hyperopic. The Swiss drug maker has unveiled a two-stage deal to buy Alcon Inc., Nestlé AG’s fast-growing eye-care business.
It is paying $10.6 billion (Rs42,294 crore) for an initial minority stake, at a 3.5% discount to Alcon’s $148.44 share price. It then can buy Nestlé’s remaining 52% at a capped $181 a share, or another $28 billion—but not until 2010 at the soonest.
The deal makes good strategic sense for Novartis, reducing its exposure to drugs whose patents face expiration. Alcon is a powerhouse in the market for certain vision-related surgical products and is strong in consumer products such as eye drops. But by acceding to Nestlé’s desire to delay giving up control, Novartis is putting off beneficial cost-cutting and diversification while still effectively committing a massive slug of capital.
Some rough calculations suggest Novartis will take its time to create shareholder value. It would not be obligated to buy the 23% free float, but assuming it does, and subtracting Alcon’s cash, its total cost will be about $48.7 billion. Figure Alcon’s expected 2010 earnings can grow to $2.4 billion, and throw in another $500 million of synergies once Novartis takes control. That would generate a 5.9% return on invested capital—compared with Novartis’ estimated 7.5% cost of capital.
It’s true that Alcon is growing at a faster rate than the capital costs, somewhat clouding the calculations. Meanwhile, the structure spares Novartis from immediately having to raise some $50 billion in today’s tight markets. It also has built in some downside price protection, since Nestlé’s put option stipulates a future sale at the lesser of either a 20% premium to the market price or $181. But by putting so much money at risk for such a long time in a business that it won’t control, Novartis is certainly bringing an unorthodox approach to deal-making. At the very least, it redefines what it means to take the long view.