RPT-Fitch: Novartis/GSK Deal Highlights Narrowing R&D Focus

Wed Apr 23, 2014 7:59am EDT

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April 23 (Reuters) - (The following statement was released by the rating agency)

Novartis and GlaxoSmithKline's (GSK) asset swap deal highlights the industry's growing emphasis on efficiency through more focused research and development (R&D) and the pursuit of scale in consumer healthcare, Fitch Ratings says. We do not expect the transaction to affect either company's credit rating when it completes.

As the risk and cost of bringing new drugs to market rises, we expect pharmaceutical companies to concentrate on a smaller number of therapeutic areas. With a full late stage oncology pipeline across the sector, we see oncology drugs as a key area of competition due to the high returns available and the prospects for next generation treatments, particularly in combination with already established drugs.

Adding to its already strong oncology portfolio and the potential for combination therapies are likely to be key benefits for Novartis in its acquisition of GSK's oncology business, which will consolidate the group's position as the second largest in the field. For GSK the disposal of its cancer drug portfolio, where it didn't have the scale to compete, and the acquisition of Novartis' vaccines business will enable it to focus on the stronger areas in its R&D pipelines, including vaccines and respiratory drugs.

The combination of the companies' consumer healthcare arms highlights the importance of scale in driving efficiency in this segment. The joint venture will create the second largest global consumer healthcare business, improving geographic reach and supply chain logistics. The limited geographical and product overlap should help the companies obtain regulatory approval.

If the deal is approved it's likely to have little impact on GSK's financial ratios, given that a large portion of the proceeds will be passed through to shareholders via extraordinary share buybacks, but we expect some margin benefit in the long term from cost savings. The group's business profile would benefit from becoming the global leader in the vaccines segment in addition to the improved position in consumer healthcare. This creates a more stable growth platform with still sufficient diversification.

For Novartis, FFO adjusted leverage is likely to rise to around 1.3x to 1.4x for the next two years after the deal, remaining below our 1.5x guidance for the maximum level compatible with the 'AA'/Stable rating, even after allowing for continued share buybacks and bolt-on acquisitions. Management has reiterated its commitment to the 'AA' rating category. While diversification would be reduced, it would still be satisfactory for the current rating, given the group's leading eye care and generics divisions, which have been confirmed as core businesses.

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