Novartis Still Thinking Alcon Spinoff…In 2019

Earlier this year Novartis (NVS) CEO Joe Jimenez said the company was considering a sale or a spinoff of Alcon, its surgical equipment and eye care business. The company paid a hefty penny (actually ~$50b worth of pennies) to acquire the business back in 2010, but as with a lot of M&A, things haven’t gone as planned. Many were surprised at the announcement given its seemingly accelerated timeline and it seems they were correct to be somewhat skeptical. During the company’s Q3 earnings call, Mr. Jimenez discussed the unit’s solid results, but also noted that they were going to push off the final decision on a separation until the first half of 2019.

Why the ‘long’ wait? Although the recent review indicated that ‘creating a stand-alone company via a capital markets exit could create additional shareholder value’, Mr. Jimenez said the company wants to enter a separation from a position of ‘strength’ and not weakness. That means demonstrating several quarters worth of both top and bottom line growth. In the CEO’s words, the separation is ‘dependent on continued Alcon sales growth and margin improvement, which need to be demonstrated for multiple quarters’. Hence the wait until 2019. After some pushback from analysts on the call, Mr. Jimenez noted that the first half of 2019 is only ‘4 quarters away’ which in his mind, isn’t ‘that long in terms of when we are taking the final action or when we will make a final decision’. Fair enough and reasonable, but certainly not the typical response from management in these situations.

This past quarter certainly helped the ‘trend’ with Alcon showing solid growth in both segments. Overall underlying growth clocked in at ~4-5%, margins improved and the company expects 2017 to be the ‘trough year for margins on that business’. Additionally, as part of the review, the company is shifting $700m of OTC drugs – things like eye drops and SYSTANE – to the Alcon unit from the pharmaceuticals group. The idea is that these products are sold in the retail pharmacies which is where Alcon sits and will thus fit better within its portfolio. It also provides some more heft to the company if a divestiture is ultimately executed. That said, they don’t plan on really investing much further in the business so it will be interesting to see how the long term shapes up. Overall, management believes the strategic plan to fix the business is working and expects the the unit to keep on growing and delivering in-line profitability.

Despite the constant repeating of the fact that the review indicated there is value in a separation, this sure doesn’t sound like a management team in full support of an Alcon divestiture. Not that they would ever root against their own operations, but by framing the decision in this way, it provides some wiggle room down the road if market conditions become challenging or there is ‘weakness’ in the business. That latitude might be appreciated by new CEO Vas Narasimhan, who will take over as CEO in February after Mr. Jimenez steps down.

The good news is that if the company does opt for a divestiture, it seems management recognizes a spinoff would deliver value to shareholders. According to Mr. Jimenez, ‘a 100% spin could be worth a lot to our shareholders as those who hold the shares get to write it up and those who don’t want to hold the shares could exit without creating depression in the value of the company on the market.’ Someone has been studying.

There is nothing to do now except watch Alcon’s performance over the next few quarters…and the way management talks about it. We will keep you updated.

Disclosure: Author holds no position in any stock mentioned.