By Ryan Savitz
This article is part of a two-piece segment brought to you by Bullish Bankers. I will be presenting the bull case for the Genentech and Roche deal. Despite the recent credit turmoil, the Roche (RHHBY) and Genentech (DNA) deal has been in and out of the news since it was first announced on July 21st of this year, and many analysts point towards the deal progressing towards a higher bid from Roche. The original bid by Roche came in at $89.00 per share to acquire the remaining 44.1% that they do not already own for a total of $43.7 billion.
DNA’s management saw this as significantly undervaluing the company, and the Board rejected the bid in August. An August 13th press release quoting Dr. Charles A. Sanders, chairman of the special committee, said, “The special committee is confident in the company’s strong financial and clinical momentum and its uniquely productive R&D capabilities, which will continue to enhance shareholder value. In addition, we look forward to the company maintaining its successful relationship with Roche, regardless of ownership structure.”
This was further seen and proven by Genentech’s stock price trading up to approximately $99.00 days after the press release. I will provide 3 reasons why it would be beneficial for Roche to increase their bid.
1. DNAs Strong Pipeline
Genentech is strongly committed to expanding their pipeline as they remain a leader in the Biotechnology sub-sector. In 2007, DNA reinvested approximately 21% of its operating revenues into R&D, which was a significantly higher percentage than the industry average. Although you may think, “This must have a detrimental affect on their earnings?” The answer is simply no, because in order to show such significant high earning growth rates that the market anticipates, a company like DNA must push money into their pipeline. One thing to note with the deep pipeline is the multiple uses available for each specific drug.
Let’s break it down by phases:
- Phase I: 21 drugs in Phase I with a total combined usage for 26 treatments (Oncology - 13 drugs, Neuroscience - 1 drug, Immunology - 6 drugs, and Tissue Growth & Repair - 1 drug). Although the succession rate is not severely high for drugs in Phase I, DNA continuously reinvests their revenue in order to deliver the most effective and efficient drugs to the market
- Phase II: 12 drugs in Phase II with a total combined usage for 25 treatments (Oncology - 9 drugs and Immunology - 3 drugs). Avastin is waiting on 3 different uses in this Phase. We will highlight more on Avastin shortly
- Phase III: 12 drugs in Phase III with a total combined usage for 34 treatments (Oncology - 7 drugs, Immunology - 3 drugs, and Tissue Growth & Repair - 2 drugs). Avastin has 16 treatments in this Phase
- FDA Submission Prep: Avastin for relapsed glioblastoma multiforme and Xolair for pediatric asthma
- Awaiting FDA Action: Avastin for first-line metastatic renal cell carcinoma and Rituxan for rheumatoid arthritis DMARD-inadequate responders
Data as of October 14, 2008
As you can see with such a deep pipeline the amount of uses per drug is astounding. Although DNA does reinvest a hefty amount into expanding their pipeline, the trade-off has been, and will continue to be, quite attractive.
2. Avastin
By definition, Avastin is a recombinant humanized antibody to vascular endothelial growth vactor (VGEF) and is designed to bind to and inhibit VEGF, a protein that plays a critical role in tumor angiogenesis. Avastin is being studied worldwide in more than 450 clinical trials and in more than 30 different tumor types. The single drug contributed $2.3 billion in revenues during fiscal 2007 and is currently in a late stage study (3rd to date) for adjuvant colon cancer treatment. The best news DNA received recently came early last week on October 20th when a clinical study of Avastin along with chemotherapy in patients with early-stage bowel cancer is expected to continue as planned after independent experts backed its safety record. The final-stage Phase III study results, which involves some 2,710 patients, are expected in mid-2009. Analysts Karl-Heinz Koch said, “The timing of this announcement is somewhat surprising as the next interim analysis was not expected until the end of November and may have been requested by Genentech as part of its attempt to push up the takeover price for its remaining minority shareholders.” Avastin was responsible for 26.7% of product sales in 3rd Quarter of 2008 and some analysts project it accounting for 38.5% of product sales by 2012 (I feel this number may be somewhat conservative looking at all the potential treatments that are currently in trials).
Morgan Stanley predicts “the market will need to markedly increase the probability of success of Avastin in adjuvant breast cancer, a $5 billion potential market in the United States alone.
3. Great Relationship
For Roche, increasing a bid is pretty much a no-brainer. Having a majority stake in DNA has kept Roche as a leading provider of oncology treatment, and Genentech’s Oncology segment contributed 39.6% to Roche’s Pharma division in 2007. The partnership has lasted over 18 years and has been extremely beneficial for both sides. In 1990 Genentech and Roche Holding Ltd. of Basel, Switzerland completed the initial $2.1 billion merger. From that day on, they have worked collaboratively towards expanding upon the relationship and becoming the leader in multiple industries. With the deal going through, Roche will be able to penetrate the US markets more, and similarly, DNA will push forth with their blockbuster drugs into the international markets.
Conclusion
Of course financing is an obvious issue in this current market; however, analysts are pushing for a higher bid coming mid-2009 which I feel adamant about as well. Expect a bid coming in somewhere between $103-$110 range. The next few months will be quite exciting following Avastin news as well as the pending deal, so stay tuned for additional updates from Bullish Bankers.
Disclosure: The mutual fund that the author manages is long DNA.
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Sources :
- iStockAnalyst: The Bull’s Case For Genentech, November 03, 2008 11:59 AM
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