#3 Novo Nordisk - Management, subsidiaries and competence

During my research on Novo Nordisk I could see a strong focus in GLP-1 drugs on almost every article, podcast or company report I checked: what are they, their benefits and how are they changing diabetes care while opening a new obesity market.

However, other topics such as the ownership structure of Novo Nordisk, management incentives and the company’s subsidiaries are usually overlooked.

In today’s newsletter I will cover those topics, among others, usually overlooked.

DISCLAIMER: This article is not a recommendation to buy or sell any financial instrument, the content is educational and my personal opinion. Each person has to make his own analysis. Any action or decision you take as a result of viewing this article is your sole responsibility.

Note: All visual material is supplied by Novo Nordisk unless otherwise stated.

Ownership at a glance

The company structure is more complex than what it might seem as it is part and effectively controlled by a larger holding, Novo Holdings A/S.

This holding has 28.1% of Novo Nordisks’s equity, controlling 76.9% of the voting rights (every Novo Holdings share has 10 votes). Same occurs with Novozymes, 25.6% shares owned by the holding and 72.7% of the votes. Simultaneously, Novo Nordisk Fonden (Novo Nordisk Foundation) owns Novo Holdings A/S completely.

Novo Holdings works as the portfolio management vehicle of Novo Nordisk Foundation. It receives funding in the form of dividends and share buybacks from Novo Group companies (Novo Nordisk and Novozymes) which the reinvest on the “Investment Portfolio” segment. This investment portfolio generates a return which is reinvested by Novo Nordisk Foundation.

Therefore, the owner of Novo Nordisk is Novo Nordisk Foundation. But what is Novo Nordisk Foundation?

The Novo Nordisk Foundation defines itself as “an independent Danish foundation with corporate interests”. The foundation was established in 1989, following the merger of Nordisk Gentofte and Novo Industri. The foundation's mission is to support scientific, humanitarian, and social causes.

Novo Nordisk old guard is currently managing the foundation. The Chairman is Lars Rebien Sørensen, former Novo Nordisk CEO while Novo Nordisk Foundation CEO is former Novo Nordisk CSO, Mads Krogsgaard Thomsen.

Its ownership rights are exerted through Novo Holdings, which represents the foundation on the boards of directors of the Novo Group companies. It seeks to consider the interests of minority shareholders and exercise its ownership in a discreet manner. As a result, the Novo Nordisk Foundation and Novo Holdings together aim to hold only a few seats on the boards of directors of Novo Nordisk (and Novozymes). Decision power is delegated to the companies, so the boards can act without having to seek approval from the main shareholder.

It is a guiding principle that a director cannot be elected to more than two of the three bodies in the Group: the Foundation, Novo Group, and the operating companies. This ensures managerial distance between the foundation and its subsidiaries.

From this structure its plausible to expect Novo Nordisk Foundation to have a long term mentality (due to the type of projects they invest in) although its operations introduce a capital allocation inefficiency as it will be bias to pay a dividend which is later used by Novo Holdings to invest on their portfolio and generate returns for the foundation to fund its operations.

Leadership

On its 100 years history Novo Nordisk has only have 5 CEOs. Current CEO (and President), Lars Fruergaard Jørgensen, was appointed back in 2017. He joined Novo Nordisk back in 1991 as an economist in Health Care, Economy & Planning. Over the years he has occupied different positions, including stays in foreign countries, even overseas as he worked in USA and Japan. Since he was appointed as CEO the company market cap has been quadrupled.

Karsten Munk Knudsen is the CFO. He started in NNIT as a finance manager in 1999 to then joined Novo Nordisk in 2003, becoming CFO in 2018.

In 2021 Mads Krongsgaard Thornsen, last member of Novo Nordisk old guard stepped down as CSO, substituted by Marcus Shindler. Schindler, unlike Fruergaard and Knudsen, joined Novo Nordisk already in an upper management position back in 2018. He worked in research in GSK, Boehringer Ingelheim as well as academia.

Management incentives

Any remuneration plan in Novo Nordisk must comply with the Remuneration Principles established by the Board. It is a policy implemented in 2019 which establishes a framework for every year remuneration package.

Firstly, the base salary compensation is established based on two benchmarks. Considering Novo Nordisk is currently the European company with the largest market cap, we can conclude (base on Figure 3) the base salary is modest.

Secondly, the bonus. The bonus programme is split in two, the Short-Term Incentive Plan (STIP) and the 3-year rolling Long-Term Incentive Plan (LTIP). STIP is measured on a yearly basis while LTIP is measured on a 3-year average. Bonus is assessed based on financial metrics, non-financial metrics and an individual qualitative performance review.

Form figures above it can be observed the only financial metrics measured to grant the bonus are sales and operating profit performance performances, meaning its growth in both cases. The non-financial metrics are related to milestones such as ensuring marketed access of drugs to more countries, the progress on investigation of new drugs candidates, CO2 emissions reduction or ensuring the accessibility of more patients to diabetes care affordability programmes.

Overall the objectives do not ensure efficient operation and value generating capital allocation as they are solely focused on growth. At this point it´s necessary to think which actions can management do to ensure their bonus without generating value for shareholders. On this particular case, management could decide to start making destructive M&A just with the intention of boosting sales, expanding the amount of candidate drugs for clinical trials which end-up being canceled due to poor evidence (although bonus would have been granted if they have progressed some investigation phases) and, this is an extreme case, commit accounting malpractices.

Is it likely management will lose focus on shareholder value creation and steer the company direction on achieving easy to meet objectives to get their bonus?

According to Novo Nordisk remuneration report, the CEO must hold shares equalling at least 2 years annual base salary while executive vice presidents must hold 1 year annual base salary in shares. Figure 6 shows executive shareholding,

Novo Nordisk share price has increased 43.89% YTD so I estimate the CEO has 288 DKK million of Novo Nordisk stock, almost 17 times his annual base salary. Moreover, he has doubled (quadrupled after stock split in September 2023) the amount of shares he owns since he was appointed as CEO back in 2017. Looking at the CFO, my estimation is that he has 12.8 times his salary allocated in shares while CSO has approximately 5 years base salary. Having a large stake of their net worth in shares will provide a strong incentive to work on shareholder value creation.

Subsidiaries & acquisitions

Novo Nordisk has always had the approach of solving its challenges by following and implementing internally developed solutions strengthening internal divisions of the company. This approach has been complemented with M&A operations.

Income generated by all these companies activities, which are not related to Novo Nordisk core business, is reported as “Other operating income and expenses”. Other operating income and expenses were 1034 DKK million (roughly 1.4% of the group’s operating profit in 2022). Subsidiaries do not greatly contribute to the company’s revenue but they do provide the specialized knowledge and resources to vertical integration of the company in critical aspects.

Subsidiaries

Some examples of segments which were internally developed from supporting the core business activities are Novozymes (spun out back in 2000) and or Novo Nordisk IT (spun out in 2015) or Novo Nordisk Engineering (subsidiary still 100% owned).

Novo Nordisk has more than 100 subsidiaries. Let’s have a look on the ones which play a major role:

1. Novo Nordisk Engineering (NNE)

   NNE was born in 1991 from the in-house consultants of Nordisk Gentofte (former Nordisk Insulinlaboratorium). 100% owned by Novo Nordisk, NNE is a leading international engineering company specialized in the pharmaceutical industry with headquarters in Virum.

   NNE has 1600 employees who work as consultants in diverse engineering projects. See figure .In 2022, the subsidiary generated 1899 DKK Million revenue, growing at a 8.5% CAGR during the last 5 years.

   

   Figure 6: NNE projects type distribution. From the NNE homepage.

2. Novo Nordisk Pharmatech

   Novo Nordisk Pharmatech A/S is a pharmaceutical company and was established in 1949 as FeF Chemicals. In 1986 FeF Chemicals was acquired by Novo Nordisk.

   Novo Nordisk Pharmatech is 100% owned by the parent company, employing 340 associates and it provides Quats (group of chemicals used for a variety of purposes including as preservatives, surfactants, antistatic agents, and as active ingredients in disinfectants and sanitizers), enzymes and silica gel.

   It generated 598 DKK Million in revenue in 2022 which decreased from 697 DKK million in 2018. This is due to the discontinuation of part of the products portfolio while rebuilding the manufacturing site for development activities.

3. Novo Nordisk IT (NNIT)

   Despite it is a separate company, Novo Nordisk currently owns a 18% stake while Novo Holdings owns 33% of its shares.

   NNIT was born in 1994 when Novo Nordisk decided to combine all its I activities. The company is operating worldwide providing IT consulting services specialized in the highly regulated pharma industry.

   

   Figure 7: NNIT headquarters in Søborg, Denmark.

   Acquisitions

   Novo Nordisk does some acquisitions, usually small if we compare the prices paid with the free cash flow generated by the company.

   Acquisitions can be divided in two group:

   1. Venture capital

      Novo Nordisk acquires companies with promising technologies in specific research areas of interest - the case of Corvidia (2020) and Forma Therapeutics (2022) on rare haematological diseases segment - and new technologies which the company can leverage on the future - Dicerna Pharmaceutical (2021) which designs RNAi treatments to silence genes that contribute or cause chronic diseases.

   2. Strategic acquisitions

      Acquisition of companies which provide or have developed a technology with the potential of becoming a strategic element of the business. Two examples are the acquisition of Emisphere Technologies (2020) - developed oral formulation technology of Rybelsus (Oral GLP-1) - and BIOCORP (2023) - French injection device developer and manufacturer, specialized in “smart” pens.

Competitors

On the diabetes market, Novo Nordisk has two main competitors, Elli Lilly and Sanofi. The three companies together have 90% of the market share, including both insulin and GLP-1 treatments. However, Elli Lilly’s and Sanofi’s portfolios are more diversified than Novo Nordisk’s (88% of revenue related to diabetes and obesity).

Novo Nordisk has been the 1st mover on the GLP-1 market, where only Elli Lilly has another marketed drug. Novo Nordisk is clearly on the lead as it is the only company offering an oral treatment for diabetes and also it is the only company offering GLP-1 obesity treatments.

Elli Lilly is expecting by the end of this year beginning of 2024 to get marketed approval of their obesity medication, tirzepatide, already approved for diabetes treatment. Clinical trials show tirzepatide provokes a larger weight loss and it has less side-effects than WeGovy. To level Elli Lilly’s treatment, Novo Nordisk has CagriSema on its R&D pipeline. CagriSema achieves weight loss percentages comparable to surgery and it is expected to get marketed approval by 2025.

Obesity drugs market is developing as we speak and Novo Nordisk its building a products portfolio for a scenario where different obesity drugs cohabit and they are prescribed based on patient weight loss needs seems likely and reasonable.

Competitive advantages

1. Regulatory barriers of entry,

   The development of any new medication or treatment needs the approval of the different national and regional pharmacological agencies.

   Moreover, compliance with the commercial distribution systems is also another barrier of entry. Drugs distribution requires specialized teams to ensure private insurers and medical agencies list a drug among the ones covered by their healthcare programmes.

2. Proprietary technology.

   Pharmaceutical industry is an intensive know-how industry: highly skilled workforce, complex R&D long-term projects and products and processes protected by patents.

   Novo Nordisk patents on their current blockbusters (Ozempic, Rybelsus, Saxenda) are not in danger on 2023 patent’s cliff. Indeed, the active ingredients are protected until next decade, with the exception in China. See figure below.

   Additionally, manufacturing processes and formulation are protected by further patents.

   

   Figure 9: Novo Nordisk active ingredients patents overview.

3. Ecosystem and vertical integration.

   As previously exposed, Novo Nordisk controls the manufacturing of its drugs, from active ingredient to final formulation and filling, including the medical devices employed, mainly pens.

   Moreover, it has subsidiaries which provide specialized workforce for engineering projects, digitalization, IT support manufacturing of other specialized chemicals.

   Further differentiation in vertical integration comes from the interaction between Novo Holdings and the subsidiaries. Novo Holdings strives for alignment of all companies of the holding, specially to serve Novo Nordisk and Novozymes interests. How will this work in practice? Let’s see some examples

   • Novo Nordisk needs an enzyme to be manufactured, then the holding will promote alignment of interests with Novozymes and/or Chr. Hansen.

   • Novo Nordisk needs CRO services, the holding owns 100% of AltaSciences; if Novo Nordisk.

   • Novo Nordisk needs consultants for manufacturing validation, monitoring adn calibration, the holding just acquired Ellab back in September 2023.

4. First mover advantage 

   Peter Thiel, co-founder of PayPal and Palantir, refutes the first mover advantage. However, in the pharmaceutical industry it does exist. When a new medication its release patients might be reluctant becoming the first users (remember Covid-19 vaccine). However, once the habit has been created and promised results have been delivered the patient rarely would like to change medication regardless of evidence of another drug with slightly better performance.

Final wrap-up

To summarize today’s newsletter (which has ended up being way longer than intended) I will just make some bullet points of the key concepts I have went through:

1. Novo Nordisk management remuneration programme rewards growth and does not ensure efficient operation. However, the remarkable share of their net worth they have in company shares (especially in the case of the CEO) and the supervision of Novo Nordisk Foundation should ensure execution aligned with shareholders interests, as done in recent years.

2. Diabetes and Obesity markets are growing oligopolies led by Novo Nordisk with large barriers of entry. Obesity drug market is now monopolized by Novo Nordisk but the TAM could be splitted between two or three players and the company would still be able to grow its revenue at a high rate.

3. Novo Nordisk vertical integration, boosted by the whole ecosystem created and nurtured through Novo Holdings A/S, it’s a solid moat (we will see in the next newsletter how is it reflected on the balance).

In two weeks, after Novo Nordisk Q3 earnings, I will finalize the Novo Nordisk saga with the fourth and final newsletter. It will cover the fundamentals of the company and its risk/opportunity analysis.

Until then… stay tuned at @SiemprePulpo