Pure Diversification

While Big Pharma struggles to determine whether the best business model is diversification or pure-play, Novartis appears to be playing it straight down the middle.

After it was leaked last week that the Swiss company is in negotiations to sell its Gerber baby food unit and other medical nutrition products to Nestle, Novartis insisted that it is not undergoing a major strategic shift and pledged to remain diversified.

The company is likely to reinvest profits from the sale--which could be as high as $5 billion--into its prescription drug business. But it will remain a player in the consumer space, focusing exclusively on its OTC brands.

John Gilardi, a spokesman in Novartis' Basel headquarters, declined to comment on what are still "market rumors" at this point. But Gregory Parekh, who heads the company's M&A group, told Pharmaceutical Executivelast month that Novartis' strategy is to spread its assets across a few core areas.

"If you look at the big M&A deals that Novartis has done," he said, "they've been to build key strategic positions in areas with fast growth rates."

Novartis has identified those areas as branded drugs, generics, and vaccines. The three areas have compound annual growth rates of 5, 10, and 15 percent, respectively. The company has 138 clinical projects in development, and has described itself as having the strongest pipeline in the industry. Medical nutrition, meanwhile, with flat growth in 2005, is considered a non-core area.

Yet consumer brands--and OTC products in particular--remain an important part of Novartis' balance sheet. The company last year purchased Bristol-Myers Squibb's consumer business and today has a healthy portfolio that includes such brands as Maalox, Excedrin, and Triaminic.

Novartis' consumer business grew to $1.9 billion last quarter, with much of the growth attributed to OTC products. In contrast, pharmaceuticals earned $5.7 billion for the quarter, generics $1.4 billion, and vaccines $374 million.

While consumer products are generally less profitable than prescription drugs, retaining that business can provide some stability for companies facing the uncertainty of R&D and regulatory hurdles.

Case in point: Pfizer. In June, the company decided on a more pure-play pharma approach, selling off its consumer brands to Johnson & Johnson for $16.6 billion. Although Pfizer garnered praise from analysts at the time--many said J&J overpaid--the world's largest prescription drug maker may be kicking itself now, in light of Saturday's news that it would suspend Phase III trials for torceptrapib due to an increased rate of mortality.

"I do think there's a legitimate argument that the ethical pharmaceutical business has gotten a lot riskier over the past 10, 15 years," said Peter Young, president of specialty investment-banking firm Young & Partners. "No one yet--none of the big firms--has shown that they know how to repair a business model that has been broken."

In addition to providing protection from the volatility of drug development, points out Elgar Peerschke, head of the global healthcare practice at Bain & Company, OTC products may experience a lift in the coming years, as consumer-directed healthcare takes shape.