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Lilly to pay dearly for Novartis animal health biz

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Wall Street analysts raised their eyebrows at the hefty price Eli Lilly and Co. will pay to acquire Novartis Animal Health.

Lilly’s Elanco Animal Health unit, which is headquartered in Greenfield, said Tuesday morning it will pay $5.4 billion for the business unit of Switzerland-based Novartis. That’s about $1 billion more than investors are currently paying to own shares of a similar animal health business.

But Lilly executives brimmed with excitement about the deal, saying the two companies’ complementary strengths would boost the sales and profits of both.

“It has a product portfolio and geographic presence that complement Elanco’s,” Lilly CEO John Lechleiter told investors during a conference call Tuesday morning, noting that 70 percent of Novartis’ sales come from outside the United States, versus only 40 percent for Elanco. “Combining these companies will enable us truly to build on the best of both.”

Elanco agreed to pay 4.9 times Novartis’ 2013 animal health revenue of $1.1 billion. By comparison, Zoetis Inc., which was spun off by Pfizer Inc. in an initial public offering in early 2013, has an enterprise value, based on its current stock price, of 3.9 times annual revenue.

Zoetis, the world’s largest animal health company, had revenue of $4.6 billion last year. The combined Elanco-Novartis would have had $3.3 billion in revenue last year, which would have ranked as second-largest.

“The deal seems expensive to us on a price-to-sales ratio,” wrote UBS analyst Marc Goodman in a note to investors Tuesday morning. Goodman noted that Novartis’ animal health business merely broke even in 2013.

Michael Leuchten, an analyst at Barclays Capital, expressed the same thought.

“In the context of precedent transactions, this is a healthy multiple and likely reflects a competitive bidding process,” Leuchten wrote in a note Tuesday morning. Bloomberg News first reported in November that Novartis was looking to sell its animal health business, with unnamed sources citing Bayer AG, Boehringer Ingelheim GmbH and Lilly as possible buyers.

Lilly shares had lost 1 percent in trading early Tuesday afternoon, down 61 cents to $60.25 per share.

Novartis’ sales and profits have been depressed since the firm had to pull two pet products from the U.S. market in 2012 because of manufacturing problems at a plant in Lincoln, Neb. Last year, it re-launched one of those products, Sentinel, which protects dogs from heartworm and fleas.

Lilly executives said they were comfortable with how Novartis has handled those manufacturing problems, which were cited by the U.S. Food and Drug Administration. They noted that the Novartis plant in Lincoln, which also makes human medicines, is not among the nine manufacturing plants Lilly is acquiring in this deal.

“We’re aware of those issues, and we’re very pleased with how they’ve responded,” said Elanco President Jeff Simmons.

Before those manufacturing problems, Novartis’ animal health business had been growing at an compounded annual rate of 8.6 percent over the previous decade, peaking in 2011 at $1.3 billion in sales. Novartis returned to a similar rate of sales growth in 2013, before the impact of currency exchange rates, Lilly officials said during Tuesday's conference call.

Assuming another year of that kind of growth, Novartis’ animal health business would have roughly $1.25 billion in sales in 2014. Lilly’s purchase price is 4.3 times higher than those expected 2014 revenues, which Lilly executives described as a “modest premium” to Zoetis’ value.

Simmons said Elanco can boost Novartis’ profitability to match Elanco’s by 2018. Elanco currently has earnings before interest and taxes of 26 percent of sales.

Lilly executives said they plan cut $200 million in costs from the combined companies by 2018, but were vague on how they would achieve that figure. They said there would be some “synergies” among the two companies’ sales forces, and that there would be “hundreds of millions of dollars” in tax benefits.

Indeed, because Novartis is a foreign company, Lilly can pay for its acquisition using its substantial foreign cash pile—which would be subject to U.S. corporate income taxes if brought back into the United States. Lilly said it would spend $3.4 billion in cash, and issue $2 billion in debt to finance the acquisition.

Simmons, in an interview Tuesday morning, declined to say if there would be any impact on staffing or operations in Indiana. Elanco employs more than 600 people in Greenfield, and about 3,500 worldwide. Novartis employs about 3,000 people worldwide.

“No question, global headquarters will remain in Greenfield,” Simmons said. “But I can’t comment on where all the resources will lie until we get further down the road on integration.”

But Lilly CEO Lechleiter stressed that having the world's second-largest animal health company headquartered in Greenfield could only be positive for the region, where the Central Indiana Corporate Partnership is trying to grow what is already a robust agricultural sciences sector.

“That’s great news for the community,” Lechleiter said.

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