Analysis: Alcon uncertainty masking Novartis drug promise

The logo of Swiss drugmaker Novartis is seen on the top of an office building at the company's plant in Basel January 28, 2009.

ZURICH (Reuters) - A string of promising new drugs and broad treatment range make Novartis AG (NOVN.VX) an attractive buy for those willing to wait out short-term weakness caused by a pending bid to complete its buyout of Alcon ACL.N.

Novartis, which bought 25 percent of the U.S. eyegroup in 2008, exercised in January an option to buy another 52 percent of the group from Nestle (NESN.VX), taking its stake to 77 percent for a combined price of $38.5 billion.

The Swiss drugmaker is now seeking to snap up the remaining 23 percent in a stock offer worth some $9.7 billion, or around $139 per Alcon share on Friday -- significantly below both the average of $168 paid to Nestle for each Alcon share and Alcon's Thursday closing price of $153.30.

Uncertainty over how Novartis intends to wrap up the deal has caused the stock to underperform the rest of the STOXX European healthcare index .SXDP by around 9 percent this year.

"We think the current valuation fails to recognize positive pipeline developments and proactive management action," analysts at Morgan Stanley said when they upgraded the stock to overweight earlier this week.

Investors are worried the Swiss drugmaker may be forced to raise its offer of 2.8 Novartis shares for each Alcon share after fierce resistance from Alcon's independent director committee, which has repeatedly dismissed the offer as grossly inadequate.

An increased offer could result in Novartis issuing more shares to pay for the deal, increasing the dilution of the stock following the close of the acquisition.

"Once the thing goes through, Alcon shareholders will hold about 9 percent of Novartis shares. The question is what will they do with them? Will they keep them? They may not want to be Novartis shareholders," Vontobel analyst Andrew Weiss said.

"There is a certain share overhang and this will remain an issue," Weiss said.

Novartis is trading at 9.3 times 2011 earnings, at a discount to cross-town rival Roche (ROG.VX), but some believe Novartis' valuation does not reflect its strong pipeline.

"The 2011 core PE of 9 times is broadly in line with the sector and reflects in our view what are exaggerated concerns over an arguably steep patent cliff and stock overhang following the planned merger with Alcon," Societe Generale analysts said in a note.

"It hardly reflects the unrivalled long-term upside from biosimilars, an industry-leading pipeline, opportunities to extend the life of the leukemia and hypertension franchises and cost reduction potential," the analysts said.

Like all other major pharmaceutical companies, Novartis will lose patent protection on key drugs, like its top-selling blood pressure treatment Diovan, in coming years.

But recent successes with its leukemia treatment Tasigna and multiple sclerosis therapy Gilenia mean Novartis is relatively well placed to navigate its way through the patent expiry period.

GILENIA GETS GOING

Novartis, which was founded in 1996 through the merger of Swiss groups Ciba-Geigy and Sandoz, is seen posting a solid set of second-quarter figures next Thursday, while U.S. approval for Gilenia, positive data on cancer drug Afinitor, gout treatment Ilaris and its meningitis vaccines could also boost the group.

"If you look at the pipeline and the product mix, which now includes a lot of specialty products with high prices and smaller sales forces, you see more profitability," Jefferies analyst Jeffrey Holford said.

"We are therefore confident that Novartis can post flat or even positive earnings during the patent cliff if it delivers well with its pipeline and product launches," Holford said.

U.S. approval for Gilenia, the first pill to treat multiple sclerosis, one of the most common disabling neurological conditions affecting young adults in the UK, would cement the treatment as a blockbuster.

Jefferies and Nomura have penciled in potential annual sales of $3.5 billion, but Vontobel's Weiss cautioned that approval from America's Food and Drug Administration is not guaranteed despite the unanimous backing from the FDA's advisory panel in June. [ID:nN09202145]

Novartis is also expected to publish data on Afinitor's use in treating neuroendocrine tumors in the next couple of days, and success in this indication could add up to $2 billion in sales, according to Helvea analyst Karl-Heinz Koch.

A late-stage study showed recently that Afinitor, which is currently forecast to have sales of around $860 million in 2014, helps patients with advanced pancreatic neuroendocrine tumors live longer without tumor growth.

"Afinitor is adding cancer indications all the time," said Jefferies' Holford.

Data from its gout drug Ilaris and its meningitis vaccine pipeline also due later this year further underline the diversity of the group's treatments.

"There is a lot of data coming through this year and we see upside of 40 percent to medium- to long-term earnings per share estimates from where we are now, although this is dependent on Gilenia becoming a multi-billion dollar seller," Helvea's Koch said.

"Novartis is a very stable company. It will have patent losses and may not grow in all years, but overall, in the medium to longer term, it will continue to grow."

(Editing by Jon Loades-Carter)