GENEVA (Bloomberg) — Nestle SA agreed to buy a unit of Swiss drugmaker Novartis AG for $2.5 billion to become the second-biggest maker of nutritional supplements for hospitals.The division has annual sales of $950 million and produces meals with added protein or calories for patients, Vevey, Switzerland-based Nestle, the world’s biggest food company, said in a statement yesterday.

The purchase will boost sales of higher-priced nutritional foods by about 20 percent for Nestle, which has spent about $1.3 billion this year buying diet-food maker Jenny Craig and cereal-bar producer Uncle Tobys. Novartis chief executive officer Daniel Vasella is selling the unit to concentrate on medicines and vaccines.

“Nestle is moving further into a great market which is highly profitable and has huge growth potential,” said Holger Geissler, a fund manager at DWS in Frankfurt, who helps manage about [EURO]1.5 billion ($2 billion), including Novartis shares. “This makes perfect sense for both companies.”

Shares of Nestle rose 9.5 Swiss francs, or 2.2 percent, to 439.25 francs at the close in Zurich, the steepest increase since August. Novartis shares gained 1.25 francs, or 1.8 percent, to 71.35 francs.

Sales of nutritional food are increasing as much as eight percent a year, compared with one to two percent for the broader food market, according to Kepler Equities. Nestle has sold divisions valued at more than $1 billion that process cocoa and coffee and make food ingredients.

The company produces foodstuffs ranging from KitKat chocolate bars and Smarties confectionery to Perrier water and Nescafe instant coffee.

The Novartis unit makes Boost drinks, designed to bring proteins, minerals and vitamins to people with ailments ranging from anorexia to cancer and aid digestion. The division also makes Nutrament energy-drink and Optifast weight-loss products. It has 2,000 employees and operates in 40 countries.

The acquisition is being entirely financed with cash, Nestle spokesman Francois Perroud said.

First-half sales of Nestle’s nutrition foods, which includes PowerBar energy snacks, Neslac baby milk and Clinutren products, rose five percent at constant currencies to 2.8 billion Swiss francs. The profit margin is 18.6 percent for the unit, compared with 12.8 for the company overall.

Nestle is betting the acquisition will help it compete with Dutch-based Royal Numico NV, which has margins of 26 percent in clinical nutrition, and market leader Abbott Laboratories, which makes hospital food in addition to heart drugs. Abbott in October said third-quarter sales of nutritional products rose 3.9 percent to $1.1 billion.

“It’s a growing market,” said Thomas Bischof of LGT Capital Management in Liechtenstein, which has about $23 billion in assets, including both companies’ stocks. “It makes sense for Nestle to expand in that area. Novartis has negotiated an attractive price.”

The purchase may position Nestle to take advantage of an ageing population. By 2050, the number of people over 60 in the world will reach 21 percent, according to the United Nations, up from ten percent in 2000. That will be the first time that people 60 and over will exceed the number of those under 15.

Numico shares added [EURO]1.12, or 2.9 percent, to [EURO]40.13 in Amsterdam, a five-year high.

Perroud declined to comment on speculation that Nestle may buy Novartis’ Gerber baby-food unit. Gerber has 79 percent of U.S. baby-food sales, according to Morgan Stanley, while Nestle has no foothold in the market at present.

Gerber Speculation

“Nestle would have to build more of a health and nutrition image into the Gerber brand” if they bought it, said Thomas Russo, who holds about $300 million of Nestle shares in a $3 billion portfolio he manages at Gardner, Russo & Gardner in Lancaster, Pennsylvania. “If they could get it at the right price, I don’t think they’d shy away.”

Numico’s third-quarter sales of clinical nutrition foods rose 10 percent to 186 million euros. Food makers have been targeting health-conscious consumers, with France’s Danone selling a yogurt that improves digestion.

Sales of Nestle’s health-care nutrition products reached $415 million in 2005, though the unit’s margins lag behind the industry average, the company said in a presentation.

Nestle estimates revenue from clinical nutrition products and foods with branded active ingredients, including its line of Clinutren puddings, grew at “double-digit” rates last year.

“The move propels Nestle into a strong No. 2 position in the fast-growing and profitable healthcare nutrition segment, where so far Nestle played only a minor role,” the food company said in the statement. Nestle said the acquisition won’t have an immediate impact on earnings.

“This looks like a very good deal for Novartis,” said Gbola Amusa, an analyst at Stanford C. Bernstein in London.

Nestle is paying 2.7 times sales and “a very healthy” 28 times earnings before interest and taxes for the unit, when Amusa had estimated the business would sell for as much as 1.5 times sales and 15 times Ebit, he said in a note to clients.

The cost of a credit-default swap based on [EURO]10 million of debt sold by Nestle was unchanged at [EURO]4,063, according to data compiled by Bloomberg. Moody’s Investors Service said Nestle’s debt after the acquisition will remain rated at Aaa, its top investment-grade ranking.