GlaxoSmithKline‘s (LSE: GSK) (NYSE: GSK.US) deal with Novartis — due to compete in the first half of next year — is transformational and boosts the already-convincing buy case for the stock. It will increase earnings per share, strengthen the company’s competitive position in growth markets, and reduce the risks in its business.
Hybrid
GSK will become even more a pharmaceutical/consumer healthcare hybrid company, rather than a pure pharma play. Straddling two defensive sectors, with emerging market growth prospects and a 5% yield, the shares have a place in most portfolios.
GSK is to sell its oncology business to Novartis for $16bn, buy the Swiss company’s vaccines business for $7bn, and pool its consumer healthcare business with that of Novartis to form a joint-venture in which it has two-thirds of the shares — with Novartis having the right to sell its stake at market value in the future. A surplus of £4bn will be returned to shareholders.
Big pharmaceutical companies have adopted a variety of strategies to address the patent cliff in the face of increasing R&D costs and tougher regulatory regimes. It’s not so easy to develop new drugs as it once was. GSK was an early mover to diversify away from R&D-heavy pharmaceuticals, growing its consumer healthcare division that sells over-the-counter products. It has also specialised, concentrating on specific therapeutic areas including respiratory and HIV drugs, and vaccines.
This transaction carries those strategies further. After the deal completes, 70% of GSK’s revenues will come from those four businesses.
Market power
Specialisation brings market power. GSK will be a clear world-leader in vaccines, with a 50% market share in paediatrics. It claims a number one position in respiratory medicine, with a 30% global market share, and is number two globally in HIV therapies.
Through the joint-venture its consumer healthcare revenues will be within sight of market leader Johnson and Johnson and streets ahead of the next-largest. The business will have 19 brands earning over $100m each and number one position in 36 geographic markets.
GSK sees ‘Rx/Cx switch opportunities’ between consumer-bought drugs and prescription (Rx) drugs, with the company’s product mix skewed towards primary healthcare, such as doctors’ surgeries. It makes sense to shed its portfolio of oncology (cancer) drugs, where it’s ranked number 14.
Cost savings
Specialisation also brings cost synergies. Novartis was struggling in vaccines, losing £100m a year. Its consumer healthcare business only makes £200m a year. Yet by combining manufacturing plant and eliminating overlaps, GSK reckons it can take £2bn a year out of the combined cost base, within five years. The £4bn capital reduction is expected to make the deal earnings accretive from year one. In the longer term GSK should become stronger, safer and with better growth prospects.