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A Drug Behemoth In The Making?


The two-month take-over battle between France's two biggest drugmakers lends new meaning to the notion of a hostile bid. Ever since Paris-based Sanofi-Synth?labo (SNY) made its audacious, $56 billion offer for Aventis, a Strasbourg drugmaker more than twice Sanofi's size, it has become painfully clear that wedded bliss isn't an option. While Sanofi Chief Executive Jean-Fran?ois Dehecq describes the proposed union as "a beautiful story for the future," Aventis CEO Igor Landau is asking shareholders to veto "a blatant attempt to acquire Aventis on the cheap." He's also running a $7 million ad campaign featuring a pill packet labeled "hostile bid" and a warning that "this medication can seriously stunt growth."

Now this straightforward hostile bid is getting a lot more complicated. On Mar. 12, Swiss drug giant Novartis announced that it was "exploring the feasibility of a combination with Aventis." A week later, the French government expressed concern about a Swiss company buying a French rival. The French government has little legal power to squash a deal, but Paris can exert considerable political pressure.

If it were up to investors, though, a Novartis bid would win hands down -- and Sanofi would be knocked off the game board. With more than $10 billion in cash and the strongest credit rating of any European drugmaker, Novartis has formidable financial firepower. Sanofi, by contrast, is stretched on the financial side -- and appears to be boxed into a corner.

"LESS FLEXIBILITY"

Landau wasn't the only one to judge Sanofi's bid low: The market did, too. Sanofi's offer is 81% shares and only 19% cash. Novartis can easily afford an offer that is 50% cash -- which would be far more attractive to Aventis shareholders. To match that cash component, Sanofi would have to triple the $11 billion in debt it initially intended to assume. "Sanofi has less flexibility," says Karl Heinz Koch, a pharmaceuticals analyst at Lombard Odier Darier Hentsch, a private bank in Zurich. "The irony is that it could find itself on the block."

If Sanofi's options are limited, Novartis' are wide open. In January it announced a record 19% surge in 2003 sales, to nearly $25 billion, and a 6% gain in profits, to $5 billion. That makes Novartis the strongest performer among the world's top 10 drugmakers. At the time, CEO Daniel L. Vasella reiterated his interest in playing a leading role in what he sees as the inevitable consolidation of the $400 billion prescription-drug industry. But after repeated attempts to woo Swiss-based Roche Holdings into a merger were rebuffed, most industry observers had expected Vasella to focus on a target in the U.S., the world's fastest-growing market. So when Novartis signaled interest in a target much closer to home -- 60 miles across the Swiss-French border, to be precise -- many in the industry were caught by surprise.

Vasella could walk away from Aventis in the end. Some Aventis drugs will soon face generic rivals, and others are mature products with little growth potential. In addition, European labor laws will make cost reductions tough for the combined companies. "Novartis is well-placed to deliver attractive growth and returns in its own right," says Mark Clark, an analyst at Deutsche Bank in London.

That may be so. But as head of the world's fifth-largest drug company, Vasella could justify a bid for Aventis easily enough. The merged company would be No. 2 behind Pfizer Inc. (PFE), with 9% of the global market. And Aventis is fast increasing market share in the U.S., where it has concentrated sales efforts on 10 drugs that offer the biggest potential. With 11,000 sales reps, a merged Novartis-Aventis would also boast the second-largest force in the U.S. That would give it a strong platform to market the 22 new drugs -- with a peak sales potential Koch puts at $16 billion yearly -- in late-stage development at both companies.

What's more, Aventis would give Novartis a boost in a number of therapeutic areas. The merged company would be the world's No. 1 player in the market for cancer drugs, with a 14% share. Aventis already makes the world's best-selling chemotherapy agent, Taxotere; among Novartis' strengths are Gleevec, the blockbuster leukemia drug, which garnered more than $1 billion in sales last year.

The market for diabetes treatments is one Novartis has long wanted to get into, but its initial offering, an oral drug called Starlix, has proved disappointing. While Novartis is developing a promising new drug, Aventis would give it a broad portfolio of diabetes products. Aventis' Lantus is the second-best-selling insulin in the U.S., behind Eli Lilly's & Co.'s (LLY) Humalog, and Aventis will launch a short-acting insulin called Apidra later this year.

Analysts believe the two would be just as powerful in the cardiovascular market. Aventis' big seller is Lovenox, an anticlotting drug, while Novartis is already a major player, with treatments for hypertension that include Diovan, Lotrel, and Lescol, which reduces cholesterol.

A VEILED WARNING

But there's a more basic reason that Vasella has gotten out the slide rule: Companies the size of Aventis rarely come into play, and he may now have a chance to acquire one in a friendly, well-priced deal. Novartis could succeed with an offer of around $78 -- $8 a share more than Sanofi's bid, say many analysts. And Aventis' Landau, who was determined to stay independent, now says "all options are open."

Still, a Novartis bid is far from certain. The risk of generic competition for Lovenox and Aventis' allergy drug Allegra is imminent, and older Aventis products are likely to weigh on sales growth. Add to this the French government's preference for an all-French deal, and a Novartis-Aventis merger begins to look tricky. On Mar. 16, French Prime Minister Jean-Pierre Raffarin issued what many analysts took to be a veiled warning to any potential foreign buyer. The government, he noted, would be "particularly vigilant in ensuring that these developments [in the drug industry] do not prejudice our national interest." Such rhetoric may lead Vasella to conclude that Aventis isn't worth the trouble.

None of these problems is insurmountable. With 80% of Aventis shareholders outside France, it's unlikely the French government could legally block Novartis or any other foreign buyer. Moreover, Aventis already is spinning off older, noncore products with combined sales of around $2 billion, and Lombard's Koch reckons that it could raise that figure to $6 billion. The next move is Vasella's. A giant company could be the result. By Kerry Capell in London


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