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An M&A Minority Report
February, 11th 2010

For shareholders, there are mergers and acquisitions and then there are M&A deals from hell. Most of the time, it takes a while to know which is which.

It may be a few months or years down the road when the promised synergies don't pan out, such as in the case of Sprint's acquisition of Nextel a few years ago. It may be right after the deal closes when the bad news becomes apparent, as when Bank of America closed its deal for Merrill Lynch.

For minority shareholders of the eye-care specialist Alcon Inc., Novartis's deal to buy the company is the rare deal that doesn't need the test of time for history to render a verdict: It stunk from day one.

Now, a looming legal battle could hold the deal up at a cost to both sides, destroying value and hurting both Novartis and Alcon's competitive position.

The trouble began on Jan. 4 when Novartis said it was buying the 75% of Alcon it already doesn't own. Novartis said it would pay $180 a share in cash to Nestle, which owns a 52% stake in the U.S. eyecare maker. Alcon's minority shareholders, many of them employees, have slammed the offer as too low. They will get 2.8 shares of Novartis stock worth about $158.90, based on Wednesday's close.

Swiss merger laws make this state of affairs possible. Alcon is based in Texas and trades on the New York Stock Exchange. But like Novartis, it's incorporated in Switzerland. The Swiss only require an "equitable" agreement between the two companies and a majority approval of shareholders. Nestle and Novartis own 77%.

This unbalanced deal, known in Wall Street parlance as a "squeeze out" has led to an outcry not only from the minority shareholders, but also from a committee made up of Alcon's independent directors that ultimately could have broader implications for minority shareholder rights.

The committee was established in 2008 to review such cases, about the same time that Novartis made its initial investment in Alcon with an option to buy more. On Jan. 20 the committee called the offer "grossly inadequate" and now are readying a legal challenge should Novartis fail to increase its offer.

"If needed, we are prepared to pursue a contested route and avail ourselves of our legal rights in court," the independent committee said in a statement Wednesday. "We firmly disagree that Novartis can simply impose this merger on the minority shareholders and we will use all weapons in our arsenal to protect the rights of minority shareholders if they continue down this path."

No response

Three weeks after receiving the committee's response, Novartis has yet to come to the table.

Novartis officials declined to comment for this column, but the company has steadfastly defended the offer to minority shareholders saying it represents a 12% premium to Alcon's unaffected share price at the time of the deal. A Jan. 5 analysis by the Wall Street Journal also found the offer to be 16 times forecast earnings and 21-times earnings per share -- a wide premium comparatively to deals in the medical equipment sector.

Novartis also set the $180 price with Nestle back in 2008 when it made its initial 25% investment and took out the option to buy Nestl's entire stake. Alcon shares haven't traded that high, topping out at just $175.13 in 2008.

But comparables probably aren't enough to assuage the minority camp and the committee. Alcon's stock was on a tear before the Novartis offer hit the books. Adding 12% in December alone and rising 30.9% in 2009. Novartis shares by comparison rose 21% in 2009 and lost 3.1% in December.

For the minority shareholders, the issue is about getting a fairer recognition of the worth that Alcon would bring to the table, the kind recognized in its deal with Nestle.

Tom Plaskett, the committee's lead independent director, said Novartis faces multiple patent expirations in the next three years. Alcon has new products it believes will breakthrough in China and other developing nations.

Mr. Plaskett said the committee sees Novartis trying to ram through a $28 billion deal saving the company as much as 18% on the backs of investors who have few options other than going to court to fight back.

"The question is why are they doing this," Mr. Plaskett said, "and the answer is because they can."

Moreover, Novartis is discouraging the very people who are key to making the merger work. Alcon employees hold a stake equal to 7% of the minority share. Novartis is effectively welcoming itself to the company by cutting their net worth.

Lasting effects
How the dispute is resolved could go a long way in setting a precedent for minority shareholder rights, a problem that's been looming as an issue in Europe, where U.S.-style protections vary in strength from country to country.

In 2005, minority investors of Arcelor alleged that Mittal was trying to force them to accept a lower price, a dispute that still hasn't been resolved. Last year, two dozen investment funds in Sweden pushed for equal rights for all shareholders in takeovers for companies listed on that country's exchange. And in December, Lufthansa, the German airline, squeezed out a minority of shareholders of Austrian Airlines at just 11% of an earlier offer.

Kraft Foods Inc.'s unsolicited offer for Cadbury plc late last year drew attention to the incongruities between U.S. takeover practices and those in the UK Kingdom. Cadbury defended itself as a company with a brighter future as an independent firm. Kraft was cast as plodding giant, eventually crushing Cadbury's resistance with a mountain of cash.

But it is one thing to sway shareholders with a king's ransom for their stakes, quite another to give a haircut to the shareholders you don't need to get the deal done. That's what's happening in Novartis-Alcon. That's what the independent committee was set up to prevent. But without shareholder protections, Novartis has no incentive to make the deal fair

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