Novartis at a Crossroads; Check Point on the Right Path

Stock Exchange lets readers listen in as Times staff writers James Peltz and Michael Hiltzik debate the merits of individual stocks.

Novartis (NVTSY)

Jim: Well Mike, since today’s your birthday, I’ll let you start.

Mike: I’ll take that as good wishes, Jim. Up first is the drug maker Novartis, which, as I read it, is the company that’s going to become synonymous with fixing irritable bowel syndrome, in all its many forms. Of course, with pharmaceutical companies, sometimes you have to talk about the things their products address, and it’s not always pretty.

Jim: Especially when you explain it. Anyway, this is one of the world’s biggest drug companies.

Mike: Thanks to the $27-billion merger between Sandoz and Ciba-Geigy, the Swiss drug makers, that created Novartis three years ago.

Jim: Novartis’ main shares trade in Switzerland, but it also has American depositary receipts--which track its Swiss stock--trading in the U.S. over-the-counter market, or “pink sheets.” Now, while Novartis is hardly a household name, some of its products are pretty well-known. They include Ritalin, for people with attention-deficit disorder.

Mike: One of the questions that we ought to address first is whether the merged Novartis delivered on the promise of putting together two massive enterprises.

Jim: Absolutely not; that’s been evident. When the merger occurred, Novartis prattled on about how it had a big interest in plant genetics. The idea was that its expertise in manipulating plant genes would yield benefits both in the production of pharmaceuticals and the development of new agricultural products--including seed stock.

Mike: And that’s a business that lately has been as flat as a Kansas field, thanks in part to growing public mistrust of genetically manipulated plants.

Jim: Exactly. And so the whole idea was that all this genetic study would help them develop new drugs and genetically modified food items--mmmm, yummy. Yet the whole thing has been a bust from the get-go.

Mike: I wonder if part of the problem is a phenomenon we may be seeing in other industries: When you put together one behemoth with another behemoth, you just get a bigger behemoth, and maybe one that moves just a tad slower than its forebears.

Jim: And we may witness yet another example, now that drug makers American Home Products, Warner-Lambert and Pfizer appear to be jostling to do another mega-merger between at least two of them.

Mike: It’s very hard to think of any of these deals that really produced the gains or efficiencies that are always promised, particularly without taking steps that stick in their customers’ craws.

Jim: Well, in Novartis’ case there have been some documented cost savings of putting these two companies together. But its whole strategy, which was to focus less on drugs and more on agribusiness, flopped. The agrichemical business is getting pounded by bad wheat prices and tons of competition.

Mike: In fact, it’s down something in the neighborhood of 25% or 26% in the third quarter versus a year ago.

Jim: On top of that, the company’s drug sales are sluggish because Novartis has aging products. Many of its patents have run out, and it now faces brutal competition from generic brands. Everyone’s waiting for the company to get some of the new drugs in its pipeline past the regulators here and in Europe and onto the market.

The upshot: The company’s financial results have been lackluster, and the stock has taken a nasty dive.

Mike: I question whether Novartis’ drug pipeline is going to fill up any time soon, or soon enough for investors to get interested in this company again. I think we’ve got a ways to go. So I’m thumbs-down on this stock.

Jim: I’m the opposite.

Mike: I had a feeling you’d say that, seeing the glint in your eye.

Jim: First, this stock has lost about 21% so far in 1999, to the high-$70s. But I’d buy it as a long-term holding, Mike. I like the fact that Novartis has acknowledged that the link between plant genetics and new drugs is not working. It’s even talking about maybe getting rid of its whole agrichemical business. I think investors would cheer that, especially since 70% of Novartis’ earnings still come from drugs.

Mike: But now that it has talked down the prospects of agribusiness so much, what kind of price would it get for that?

Jim: Forget price; just dump it. Then you’d have a pure-play drug company, which I think would do a lot better. Novartis had warned that ’99 would be a dry year for it in terms of getting new drugs on the market. But next year’s a different story. It’s got a decent pipeline of new drugs going through regulatory clearance, and several could hit the market in 2000 and 2001. And we’re talking about drugs that cumulatively could generate billions of dollars of sales.

Mike: Perhaps, if you take the best-case scenario with each drug. I’m not sure that’s a great way to bet, because it’s anybody’s guess how the Food and Drug Administration will treat them and whether the drugs are going to work nearly as well as claimed, not to mention whether they can beat competing drugs that address the same problem.

Jim: Yeah, but if you buy Novartis now, you get it for a very affordable 24 times this year’s earnings per share, and that’s way below what many big drug outfits sell for. Merck’s P/E multiple is 32; Pfizer’s is 41. Wall Street’s got everybody standing on the sidelines waiting to see what’s going to happen with Novartis. I’d stop waiting, buy the stock now on the cheap and expect those new products to really lift this company next year.

Check Point Software Technologies (CHKP)

Jim: This is one of the biggest publicly held companies based in Israel, Mike, and it’s been a stunning success of late. In fact, it exemplifies the surging interest in Israeli enterprises these days, especially those involved in technology.

Mike: Yeah, one reason we decided to talk about Check Point Software was to discuss the truly amazing entrepreneurial economy of Israel. You know, it wasn’t long ago that Israel was an economic basket case. It looked as if it was going to be permanently on the dole, mostly in terms of U.S. foreign aid. It was having intractable problems absorbing waves of immigrants from Eastern Europe and Africa.

Then one day you wake up and Israeli companies are among the richest sources of software, particularly networking software, in the world. That’s a hot field because the world is the Internet.

Jim: And Check Point’s whole business is making software to help users keep their networks secure from hackers and intruders.

Mike: To put it another way, many of our readers who log on to the Internet at their offices know the term “firewall.” That’s basically a software wall that keeps unauthorized people from penetrating a networked communications system.

Jim: Or letting workers download pictures of Cindy Margolis at work?

Mike: Check Point makes firewalls. It’s the creator of something called VPN, which stands for virtual private network products, as well as one called FireWall I. This area is growing like gangbusters, and Check Point is the dominant player.

Jim: Right, and all its stock has done in the last 12 months is nearly quintuple in price, from about $27 to around $127 or so today. And why not? Here you have the Internet exploding and all these users and networks that need to be secured. Check Point’s got quality products that are ever more in demand. Its quarterly earnings and sales keep blowing away Wall Street estimates. I mean, what else is there to say? Except, would you buy the stock?

Mike: And your answer is?

Jim: Yes. Now, look, once again I’m not wild about buying stocks that are selling for 56 times their anticipated earnings per share for this year.

Mike: Is that all it is? Because remember, you’re buying a company with net profit margins of 43%!

Jim: You’re way ahead of me. This isn’t some stock that has hardly any business and is just riding the Internet bandwagon. Check Point has a strong backlog of orders, and, as you alluded to, in the first nine months of this year it earned an astonishing 43 cents per dollar of sales after taxes. Plus it has no long-term debt on its balance sheet. They just don’t come much better than that.

Mike: This is a great phenomenon. Once a company takes on a great technology and learns how to exploit, the overhead is pretty low.

Jim: The other thing I like about Check Point is its balance. The U.S. only accounts for half its sales. Europe’s about 33%, and the rest of the world is 17%.

Now, whenever we talk about a stock this expensive, an investor has to understand that there won’t be any room for Check Point to stumble.

Mike: Because one reason people are willing to pay this much for the stock, relative to its growth, is that they see it as a company riding a lot of momentum. If that momentum falters, there’s a lot of foam that’s going to come out of the stock.

On the other hand, I think its long-term prospects are great, and I’d buy it, too.

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Write or e-mail with a stock you would like to see discussed in this column. Staff writer James Peltz (james.peltz@latimes.com) covers the markets and corporate financial trends. Staff writer Michael Hiltzik (michael.hiltzik@latimes .com) covers technology and entertainment and is the author of the new book “Dealers of Lightning: Xerox PARC and the Dawn of the Computer Age.” Either can also be reached at Business Section, Times Mirror Square, Los Angeles, CA 90053.

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You can hear a preview of Peltz and Hiltzik’s weekly column Mondays on the KFWB-Los Angeles Times Noon Business Hour on KFWB-AM (980).