The Best Defense Is a Good Offense: Sanofi's Bid for Aventis

Sanofi's attempt to take over Aventis reflects its own status as takeover material for other companies, particularly after it loses the protection of its current shareholder structure. But it is also convinced that its highly productive R&D organization can make much better use of Aventis' R&D expenditures than Aventis has done. Nonetheless, Sanofi, which has been limited in the past by its Franco-centrism, particularly in the key American market, must use the transaction to transform the company into a far more internationally managed and culturally diverse organization. Indeed, for all the European flavor of this deal, it portends an even greater Americanization of the drug business.

Whatever the outcome, the two largest French companies will look different by the time the battle's really over. And oddly enough, the drug industry will have an increasingly American cast to it.

By Melanie Senior and Christopher Morrison

• Sanofi's attempt to take over Aventis reflects its own status as takeover material for other companies, particularly after it loses the protection of its current shareholder structure.

• Sanofi is also convinced that its highly productive R&D organization can make much better use of Aventis' R&D expenditures than Aventis has done—although the tripling of the research budget would in fact create managerial challenges different in kind as well degree from those the mid-sized firm has faced in the past.

• But Sanofi, which has been limited in the past by its Franco-centrism, particularly in the key American market, must use the transaction to transform the company into a far more internationally managed and culturally diverse organization.

• For all the European flavor of this deal—the odd shareholder structure, the government intervention, the nationalism at the heart of the transaction—it portends an even greater Americanization of the drug business.

Sanofi-Synthélabo's bid for Aventis SA is at once defensive and bold. Defensive since Sanofi has only nine months before it becomes vulnerable to takeover itself, when a pact between its two largest shareholders expires. Bold for being hostile and aimed at a compatriot whose revenues are more than twice Sanofi's.

The two companies had been dancing around each other for months. But few expected until the very end the smaller player's hostile bid for its Franco-German neighbor on January 26, offering €48.3 billion ($60 billion) in cash and stock. [See Deal]

Still, Sanofi had little choice. If it couldn't sign a deal before year-end—and an amicable one with Aventis appeared unlikely--it risks being bought by someone else when the pact between its two largest shareholders, Total and L'Oréal, expires in December. (That pact is itself a result of the company's last merger, in 1998, between Elf Acquitaine (now Total SA), Sanofi's former parent, and L'Oréal's Synthélabo. [See Deal]) Sanofi's chairman and CEO Jean-François Dehecq struck while he could: higher margins and growth, plus a stronger pipeline, had pushed Sanofi's market cap close to that of Aventis despite having sales of less than half its target.

The French group's better-than-average R&D productivity has made it attractive to a range of Big Pharma players, until now kept out by the Total/L'Oréal pact. (See "Nous Voici! Sanofi's Leap to the World Stage," IN VIVO, July/August 2001 (Also see "Nous Voici! Sanofi's Leap to the World Stage" - In Vivo, 1 Jul, 2001.).) "Dehecq has to succeed [with the Aventis bid]. He's now very, very exposed [to takeover]," asserts a French commentator. "Some Big Pharma appear reluctant to move in as a white knight for Aventis, yet they all say Sanofi is interesting," the commentator continues.

Yet Dehecq, renowned for his effusive management style, wants to avoid at all costs the loss of control that would result from being subsumed into a larger group. "Dehecq is a man of great ambition," comments one senior pharmaceutical executive at another French firm.

He's also firmly convinced of his R&D group's superiority. "He'd love to grab the €2.9 billion Aventis is spending on R&D and put that under [Gérard] Le Fur [Sanofi's EVP, scientific affairs]. That's money he thinks Le Fur would really know what to do with," says one analyst. A combination with Aventis would more than triple the €1.3 billion Le Fur had to spend in 2003. Indeed, Dehecq has always felt that Sanofi's research was underfunded: the main reason for Sanofi's diversifications as it was growing—into cosmetics, bio-industrial products, medical devices and diagnostics, all businesses the company has since exited—was to provide money for its pharmaceutical R&D, Dehecq told IN VIVO in 2001. (See Exhibits 1 and 2.)

The French Connection

Dehecq is also a nationalist, often seen with other key French businessmen at President Jacques Chirac's side. Dehecq doesn't merely want to build a leading drug company (an Aventis merger would create the world's number three in sales and R&D budget terms), he wants to build a leading drug company that's French. Tying up with Aventis (created from the merger of France's Rhône-Poulenc with Germany's Hoechst in November 1998 [See Deal]) is the only way that can be achieved within the timeline of Dehecq's remaining tenure, even though only 21% of Aventis' shareholders are French.

Small wonder, then, that the French government has been vocal in its support for the bid, notwithstanding some likely job cuts in France, where a combined group would have more than 30,000 staff. Government support still matters in socialist France, even though they know it is not supposed to. The country won't block all hostile takeovers where the French company is the loser—Canada's aluminum giant Alcan won French national champion Pechiney SA in 2003 (Dehecq learned first hand about hostile transactions as a Pechiney board member). But it still defends its major corporations, particularly in health care, where "there's a perception that the country must retain its independence," according to one French executive.

Some analysts are speculating that government support helps explain why Sanofi didn't bid instead for Bristol-Myers Squibb Co. In market terms roughly the size of Aventis (at least before the run-up in Aventis shares since deal rumors began last fall), Bristol would be a logical partner given the existing marketing deals on Sanofi's irbesartan (Avapro) and clopidogrel (Plavix), and a stronger US presence than Aventis can offer. [See Deal]

But a bid for Bristol would be problematic. In the first case, Bristol's problems continue to resonate in the industry—it's under government investigation over its inflation of profits by stuffing distribution channels with excess product—and no one really knows what hidden landmines might still explode.

And second, buying a US company would have been difficult for Sanofi because of so-called flow-back issues: major US investment funds have limits on the amounts of stock in ex-US companies they can hold. They would thus have to sell their positions once the US company was part of Sanofi, with the result that Sanofi share values would fall precipitously.

Rebuttal

Aventis' management rejected Sanofi's offer outright, declaring that it grossly undervalues the company, and is simply a last-ditch attempt by Sanofi to dilute its exposure to the generic threat to Plavix, which accounts for over a third of Sanofi's revenues. "The offer isn't just below the line. It's below below the line," emphasized Aventis chairman Igor Landau at the company's results meeting in London on February 6. Sanofi claims it could save €1.6 billion annually by combining with Aventis. Aventis scoffs at the notion, figuring that its own plans will generate far more positive value without the attendant disruption. Aventis managers pointed to progress with its divestment programs and internal cost savings plans, the creation of a joint venture to manage €1.5 billion of non-core products, launching four new drugs in 2004 after having registered five in 2003. Given time to consider "alternative scenarios," they said, we can offer shareholders a more attractive, less risky proposition than Sanofi's offer.

Indeed, argue Aventis executives, the bid could destroy value. Because of the hostile nature of its bid, Sanofi can't know all the key change-in-control provisions of Aventis contracts for important in-licensed products, like ciclesonide from Altana AG . [See Deal] In Altana's contract with Pharmacia on roflumilast [See Deal], for example, the German company wrote in a strong change-of-control option which would have allowed it to pull the product out of the alliance when Pfizer Inc. acquired Pharmacia. [See Deal] It apparently took an extraordinary effort from Pharmacia to convince Altana to keep the product with Pfizer.

Aventis is hardly likely to show the same kind of cooperation. "I find it astonishing that companies launch hostile bids in this sector," said Landau at the results meeting. Sanofi doesn't "know anything" about Aventis. Not quite: there are several former Aventis executives now at Sanofi, though how much they know about the different contracts isn't clear.

Still, Aventis' protests about its aggressive new value-enhancement initiatives (like the joint venture and the divestments) come somewhat late. Why hadn't they said much about them until now? "It's not our culture to talk about things we haven't yet done," Landau told In Vivo Europe Rx. "Under the present circumstances, we are. But we don't think our philosophy is wrong." Still, the Sanofi bid has probably accelerated Aventis' strategy to improve its business and thus, even if the deal doesn't go through, its prospect will have kick-started Aventis into more aggressive action.

It's clear that Aventis isn't averse to M&A—a large component of Aventis' "alternative scenarios." Yet, says Landau, "if we wanted to build a broader base through M&A, we would want to create a number one, not merge number five with number 14," he said. "The general idea [of M&A] is sound, in an industry that needs big R&D budgets. There are drivers that force people in that direction," comments a company spokesman. With Sanofi, "it's just the way they did it" that is disagreeable, the spokesman continues.

Moreover, Sanofi is offering a premium for Aventis far less than the 33% in Pfizer's acquisition of Pharmacia, or the 35% in the General Electric Co. /Amersham PLC tie-up. [See Deal] Hence many analysts think Sanofi must—and can afford to—raise its offer; they believe the Plavix exposure has already been figured into the Sanofi stock price—and in any event, their consensus is that Sanofi is likelier to win than lose the litigation.

Meanwhile, Aventis stock, which has risen dramatically since acquisition rumors began, now seems fairly well valued for a company that is facing generic liabilities at least as severe as Sanofi's. Both Aventis' €1.6 billion anticoagulant enoxaparin (Lovenox) and its €1.7 billion allergy medicine fexofenadine (Allegra) are in the midst of patent battles against would-be generic competitors. And Allegra has already been hit by the US managed care groups' backlash against prescription allergy drugs. Meanwhile, few analysts seem taken with its pipeline.

Forced U-Turn on M&A?

The expiry of the shareholder pact and the potential for Plavix's genericization are not only forcing the timing and nature of the takeover bid, they are also forcing Dehecq to change strategy. Sanofi hasn't until now been a proponent of the bigger-is-better approach that many drug firms have pursued; it has been happy to remain firmly in the mid-sized category. Now, however, Dehecq is "forced to abandon a model he knows works for one which might work," says one top executive at a mid-sized French firm. According to consultancy Bain & Co., most pharma acquisitions haven't led to increases in market value or profit margins beyond what one would expect through sum-of-parts calculations.

Dehecq claims a strategic rationale behind a Sanofi-Aventis tie-up: critical mass in R&D, a leading European presence, and a major US footprint, which Sanofi has failed to create alone. And all that comes with very little product overlap; the deal will thus likely escape much damage from antitrust regulators who, in other deals, have mandated significant product divestitures.

The question is whether Sanofi can use the acquisition to improve its own business. The company's US performance has underwhelmed, note former and current Sanofi executives in America, in part because its tactics and strategies have been directed so forcefully by Paris. Nine of Sanofi's top 12 managers are French—only Timothy Rothwell, president and CEO of Sanofi's North American operations, is American. Eleven of 13 board members are French. Its most important cancer drug, oxaliplatin (Eloxatin), faced major development delays in large part, say these US executives, because the company's European bosses took their own counsel, going for a first-line indication without understanding US requirements.

It is, nonetheless, doing quite well now--unlike the anticoagulant fondaparinux (Arixtra), a major disappointment for the US operation. Forecast to do about €350 million by 2005, it is annualizing at barely €30 million worldwide.

Moreover, the company's research has been fiercely inward looking. One US executive noted that the American business development group has been basically forced into inactivity--in part to keep earnings up, in part because of the dominance of internal R&D. That's understandable, given that internal R&D has indeed delivered the required results.

But historically, companies which rely so extensively on internal programs eventually find these pipelines run dry. Moreover, Sanofi's R&D management has had the luxury of managing what is today a mid-sized organization. The problems of running an organization three times larger are not merely different in degree—they are different in kind.

Transforming Opportunity

Still, by taking over Aventis, Sanofi has the opportunity to address what many would see as its major weaknesses. Aventis—for all its Franco-German roots and Strasbourg headquarters—is by now largely an American-driven firm. Most of the commercial organization, the R&D organization and business development are all run out of its New Jersey facilities. Far less productive per R&D dollar than Sanofi, Aventis has nonetheless done an admirable job with post-approval development of both its cancer blockbuster docetaxel (Taxotere) and Lovenox. Its marketing organization has skillfully turned the now threatened Allegra into the number-one product in its class.

If Sanofi were to allow Aventis managers to apply these same skills to their own products, the benefits could be significant. Zolpidem (Ambien), Sanofi's sleeping pill, with €1.4 billion in worldwide revenues, will probably face competition from Sepracor Inc. 's eszopiclone (Estorra) and, a year later, Pfizer's indiplon—and go generic in 2006. Aventis' consumer marketing experience could dramatically help the transition from standard Ambien to the new modified-release version, the launch of which is expected in 2005—barely enough time to prevent massive generic erosion in the base business.

The strategic model would be Novartis AG , which used the opportunity of merging Ciba-Geigy and Sandoz to transform the company into an international powerhouse, run by managers from a wide variety of countries. [See Deal] Novartis may be headquartered in Switzerland, but its research is run out of Boston, development in Basel, marketing by an American, and the overall pharmaceutical operations by a German from the consumer-products world. The group strategically changed direction, putting primary care together, re-focusing the pipeline, and creating far-reaching organizational change that contributed to much of its increased growth. (See "Renewing Novartis," IN VIVO, January 2001 (Also see "Renewing Novartis" - In Vivo, 1 Jan, 2001.).)

Getting Over Hostilities

Creating such transforming operational synergies will require tremendous intra-company cooperation. But these two companies are culturally "day and night," says one senior French executive. Sanofi's focused, military management style, he says, contrasts strongly with Aventis' more fluid, politicized system. "This company doesn't feel French at all," adds one Aventis employee.

Adding to the problems of merging the two companies is the hostile nature of the bid. If the deal does close, Aventis' senior management is likely to flee. That's what happened when Pfizer acquired Warner-Lambert after its hostile bid. [See Deal] And the same thing happened in the friendlier, follow-on deal, Pfizer's acquisition of Pharmacia. Yet to Pfizer, the management exodus mattered less: they were buying products, not people.

Sanofi, on the other hand, needs people, particularly to leverage the Franco-German group's stronger US presence. But for political reasons, many of the required cuts will likely fall in the US, where it is far easier to fire people than it is in France, or even in Germany. And yet it is in France and Germany where many of the cuts most logically should take place. Aventis executives themselves note, privately, that their French and German operations are highly over-infrastructured. Meanwhile, nearly 40% of Sanofi's workforce is based in France, despite France representing less than 5% of the global drug market. That's why the French press is filled with stories of worried employees at Sanofi and Aventis sites in France. At the same time, the German press reports public worrying by top German politicians over job cuts. France won't want to antagonize its European neighbor by letting the axe fall too heavily there.

At this stage, most analysts are betting that Sanofi will win the battle. Most of the American potential white knights mentioned in the press--Johnson & Johnson , Bristol and Pfizer—don't need Aventis' American infrastructure: Pfizer is still digesting Pharmacia, Bristol has significant operational problems it must solve first. Procter & Gamble Co. could benefit, but the last time it tried to act as a white knight, trying to rescue a combined American Home/Warner-Lambert from Pfizer's Warner bid, it was roundly punished by shareholders, who ultimately ousted its CEO. As for European white knights: Novartis is more interested in Roche while GlaxoSmithKline PLC , according to an analysis by Sanford Bernstein & Co. analyst Catherine Arnold, would face the most dilution from buying Aventis of any of the possible acquirers. (See Exhibit 3.)

Continuing Americanization

French government support will do a lot to further Sanofi's interests—particularly in blocking competing bids. "The French government has a long memory," says Arnold. "If another company comes in and breaks up the deal with an aggressive bid, it might leave a poor taste in the mouth of French regulators which they'll remember when it comes time for the next product reimbursement negotiations."

Whatever the outcome of this European battle, both Aventis and Sanofi will likely look different in the next year or two. If Sanofi loses, it will probably find itself the target of someone else—after all, Sanofi is basically arguing that it isn't big enough on its own to capitalize on its pipeline opportunities. And even the French government, in backing the combination, seems to agree. There are plenty of pipeline-poor companies who would like to get their hands on Sanofi's research output which would conveniently come without the US infrastructure they'd probably have to prune away in any event. Meanwhile, Aventis has already hinted that other merger possibilities would make sense. And it has promised to meet some aggressive growth and cost-saving goals—if it fails to do so, the markets are likely to abandon the company, leaving it without protection from an even lower acquisition bid.

And not only will these two companies look different: so will the industry. Dehecq's hostile attack has already brought a US-style tactic to Europe. But to make Sanofi a success will require it to adapt its Franco-centric decision-making to Aventis' far more American way of doing business—particularly when Sanofi must find ways to grow a business with combined 2004 revenues estimated at €26 billion, not the mere €8.8 billion it would have on its own. That won't happen by focusing on Europe—where the combined profit pool, according to Bain, has shrunk to a third of the worldwide total, while the US has increased to nearly two thirds--or by applying European marketing, development and managerial standards in the rough-and-tumble US market. Indeed, for all the European flavor of this deal—the odd shareholder structure, the government intervention, the nationalism at the heart of the transaction—it portends an even greater Americanization of the drug business.