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Roche’s Acquisition of Genentech - Summary

Roche is a global pharmaceutical company headquartered in Switzerland, founded in 1896 by Fritz

Hoffmann-La Roche. The company’s strategy was to develop new products through cooperation with
academics. By 1914, Roche was a global company, with offices all over the world.

Since 1990, Roche owned 56% of Genentech, its biotech subsidiary in California. The chairman of
Roche, Franz Humer, decided to acquire the remaining 44%. The deal was seen as one of the most
successful partnerships ever by people in the industry.

In 2008 Roche offered 89$ per share of Genentech (8.8% premium). A special committee was
created to protect minority shareholders and this committee saw the offer as inadequate and valued
Genentech’s stock at 112$ to 115$ per share. Then came the crisis and stock prices declined, so the
special committees’ valuation wasn’t accurate anymore. In January 2009, their offer was open for six
months and there was no deal, so they thought they could not acquire Genentech for sure.

Roche’s investment bankers suggested making a tender offer for Genentech’s shares. Humer
thought that would alienate their managers and employees, many of whom were shareholders. That
and the uncertainty of Genentech’s future got the chairman worried about hiring new or retaining
old employees. Because of the crisis, debt financing the tender offer would be difficult.

History of Roche

 After WWI they primarily sold synthetic vitamins.

 After WWII they intensified their pharmaceutical research to avoid becoming too dependent on
vitamin sales. The company successfully introduced a drug called Gantrisin and the first
effective treatment for tuberculosis, he first cancer chemotherapy drug, and the tranquilizer
 In 1965 the new chairman decided to research more on treatment not based on synthesized
substances, creating the Institute of Molecular Biology and Basel Institute for Immunology.
Those provided major breakthroughs.
 In 1978, the new CEO made new investments and alliances. During the 1980s and 1990s,
biotechnology, which used living cells to make therapeutic proteins (instead of making drugs
from chemicals found in plants or molds), emerged as a new method of synthesizing drugs. In
the 1990s, Roche bought a majority of Genentech, a biotechnology firm, Nicolas, a non-
prescription drug company, Syntex, a bioscience company and Boehringer Mannheim, a
diagnostic leader.
 In 1998, Franz Humer became CEO and decided that Roche should spend more on R&D and
focus on innovation.
 Roche went through a period of intense financial stress in 2001 and 2002. In 2001, Roche’s rival
Novartis bought 21.3% of Roche’s voting shares, then increased to 32.7% in 2003 with a view to
an eventual merger. However, the families that owned most of the firm and the board said that
they will not agree on an acquisition.
 In 2012, Roche had a $2.9 billion loss after significant write-offs.
 They recovered in 2003 and outgrew the market ever since. Their success was due to the strong
sales of a diverse portfolio of drugs (innovation paid off).
 In 2008, the Roche Group generated revenues of CHF45.6 billion and net earnings of CHF10.8
History of Genentech

 Genentech was founded in 1976 by venture capitalist Robert Swanson and scientist Herbert
 They were the first biotechnology firm to go public (in 1980) and the first one to produce a
human protein in a microorganism (E. coli bacteria), and to clone human insulin and human
growth hormone.
 Early on, the company used licensing deals with big pharmaceutical companies to finance new
product development.
 Genentech combined scientific excellence with business acumen (= good judgement).
 On the IPO their share price went from 35$ to 88$ in one hour.
 By 1998, Genentech’s revenues exceeded $1 billion, and under the leadership of Arthur
Levinson, the Genentech R&D pipeline grew stronger by the day.
 By 2008, Genentech had become a vertically integrated pharmaceuticals company, researching,
producing, and selling its own products in the U.S.
 In terms of revenue, it was second largest among biotech companies in 2007,

Roche and Genentech

 In 1990, Roche acquired 60% of the equity of Genentech for $2.1 billion.
 Genentech was Roche’s biotech subsidiary in California
 The benefits of the alliance with Roche: stable source of financing for Genentech’s R&D, access
to Roche’s extensive marketing and distribution channels, especially outside the U.S, still
allowed Genentech to remain a public company and to continue compensating employees with
stock options.
 Roche had stock options to buy shares of Genentech. In 1995, they did not exercise the option,
but instead obtained approval to extend the maturity of the option.
 In June 1999, Roche exercised its option to purchase the remaining Genentech shares at the
price of $82.50 per share.
 Roche later sold and rebought shares a few times.
 Although they had a majority of shares, Roche decided to maintain a minority representation on
the board, although they had the right to have majority representation in the board
 They made an agreement so that Roche has exclusive rights to commercialize Genentech drugs
outside the U.S. This agreement also stated how a Roche merger of Genentech would be
organized. In case of a friendly deal, board approval (leaving out Roche’s representatives in the
board) would be sufficient and all shareholders would be paid the same price. In case of a
tender offer, the affiliation agreement had additional implications. Roche would most likely
have to buy the shares at a price above the tender offer price. Plus, if Roche owned 90% or
more of Genentech’s total shares for more than two months, they were required to merge.
 Products originating from Genentech represented 46% of total sales of Roche’s 20 top-selling
drugs on a worldwide basis.
 Genentech operated in most respects as a fully independent company, and many Genentech
employees were not aware that Roche actually owned a majority of the shares.

Roche Considers Buying Out Genentech’s Minority Shareholders

 By 2007, the global pharmaceuticals market was enjoying rapid growth.

 Most pharmaceutical companies stopped innovating and creating new drugs, the new trend
was to grow through mergers and acquisitions. Another trend for pharma companies was to
diversify from the prescription drug business by acquiring generic-drug companies and other
adjacent businesses such as medical devices, diagnostics, ...
 In 2007, Roche’s managers began to question the structure of the Roche-Genentech
relationship. Genentech was becoming Roche’s competition in several U.S. markets.
 Genentech had grown from a nimble biotechnology firm to a fully integrated biopharmaceutical
company and there was an increasing overlap and duplication between the two firms.
 A merger of the two companies would create new opportunities, including “the ability to
collaborate on a worldwide scale”
 Plus, the product licensing agreement, put in place in 1999, was due to expire in 2015 (The one
that gave Roche the right to opt in to development and to commercialize Genentech products
outside the U.S., giving Roche access to important products of Genentech’s innovative R&D
work) This licensing agreement was supposed to be renewed, but could be sold to another firm
who would bid the highest price.
 A merger would avoid this problem, but the merger should not disrupt Genentech’s unique and
innovative R&D efforts
 Another pro of merging would be that the laws about intellectual property rights would not
block information sharing between the researchers of both companies anymore
 A pro outside of R&D was the possibility to create value by cutting costs and streamlining
operations in manufacturing, G&A, and commercial operations (Economies of scale/scope?)
In order to find out what could be achieved, in the first half of 2008, Roche managers conducted
a detailed, strategic analysis of synergies obtainable if Roche’s and Genentech’s operations
were combined. They identified $750 million to $850 million in annual savings realizable over
five years.
 Another reason to merge was that Genentech had lots of cash (from high cash flows in the past
years and not paying dividends for a long time) which Roche could not access, although it
appeared on their consolidated balance sheet. If Genentech paid out dividends, some of them
would go to the other shareholders and some of it would be lost to taxation. Obtaining the cash
by repurchasing Roche’s shares would decrease their equity stake. And finally obtaining cash
through loans would raise questions about potential conflicts of interest. If the companies
merged, Roche would have direct access to Genentech’s cash.

Roche Makes an Offer to Genentech’s Board

 Roche’s advisors (Greenhill and Co.) said that this acquisition would be quite difficult since
Genentech was a blue-chip stock (market leader in that industry, with high market capitalization
in the billions)
 On Monday, July 21, 2008, before the stock market opened in Zurich, Roche announced publicly
an offer for all outstanding shares of Genentech that it did not already own. The offer was for
$89 per share, in cash (8.8% premium over Friday’s close), valuing Genentech at $100 billion.
They planned to finance the transaction through a combination of its own funds and debt
financing, but many key market players were Tceptical that Roche would be able to secure the
financing on reasonable terms. On the announcement, Genentech shares jumped $12.06, or
15%, closing at $93.88. In late Monday trading in Zurich, Roche shares dropped CHF 8.6, or
4.8%, to CHF 171.
 Analysts feared that Genentech would lose its intellectual property and that lots of important
scientists would quit after the acquisition, out of fear that Genentech would lose its
independence and entrepreneurial spirit. Roche replied to the concerns by saying that
Genentech will remain autonomous and able to decide themselves which projects to pursue or
not. They also announced that the precise conditions would be determined through
negotiations with the independent directors, who they advised to hire financial and legal
counsel in order not to be facing a lawsuit.
Genentech’s Response

 Genentech created a special committee of independent directors to be appointed to consider

the offer. Those would decide whether the minority shareholders should accept or reject
Roche’s offer.
 The committee’s first action was to recommend employee retention and severance plans;
Roche quickly agreed.
 Then they said that the offer should be rejected, since it undervalues the company, but that
they would be open to new offers which acknowledge Genentech’s value.
 The discussions continued until September, when both CEO’s agreed that longer the acquisition
process continued, the more likely it was to negatively affect morale and Genentech’s ability to
attract and retain key employees.
 Roche still wanted to go through with the acquisition, but the special committee didn’t say
which price would be acceptable. However, Roche refused to augment the price, without the
special committee and advisors explained and justified the basis for a different valuation, thus
convincing Roche that the business was worth more.

Valuations of Genentech

 Before the offer, Greenhill & Co. used several methods of analysis to estimate a fair value of
Genentech’s shares. First based on the forecast contained in Genentech’s most recent long-
range plan (The June LRP), which contained detailed projections of revenues, expenses, capital
expenditures, and changes in net working capital for 10 years. Then by working together with
Roche’s internal M&A team to estimate Genentech’s FCF in the next 10 years and thereafter
using perpetuity. They used a Tax rate of 35%, CoC of 9% and growth rate of 2%. The weighted
average cost of capital was based on interest rates and betas as of June 2008 and a market risk
premium of 7.1%. From the estimated enterprise value, Greenhill subtracted Genentech’s
short- and long-term debt, added back its cash and marketable securities, and divided by shares
outstanding to obtain a value per share. For different long-term growth rates, they obtained a
valuation range of $73.94 to $81.54 per share.
 Roche’s managers’ view was that because Roche already owned a majority of Genentech’s
shares, the acquisition of the remaining shares did not constitute a change of control. Thus,
Roche did not include a control premium in its offer. (this premium was already previously paid
to acquire the majority of shares)
 Grennhill presented three more analyses: (1) an overview of offer premiums paid in similar
“squeeze-out” transactions; (2) a comparison of EBITDA and earnings multiples for selected
comparable companies; and (3) a review of the consensus price target of Wall Street analysts.
All three analyses confirmed the valuation range of $70 to $80 per share.
 Thus, the offer of $89 was already way above the standard valuation methods and Roche’s
advisors didn’t understand why Genentech’s committee said it was an undervaluation.
 In November, Genentech presented a new financial forecast to Roche. This forecast assumed
higher future prices of existing drugs, a higher likelihood of success for drugs in the pipeline,
lower investment needs, and a lower effective tax rate. This November financial model (NFM)
resulted in a valuation of $112 to $115 per share. Roche’s CEO was like woah wtf.
 The aspects that differed in the NFM from the June LRP were higher total revenue, longer
period that was forecasted (until 2024 instead of 2018), higher growth rate, different cost and
expenses ratios. The assumed tax rate, depreciation expense, change in net working capital, and
capital expenditures were all lower. Average total cost as a percent of revenue was virtually
 Roche’s managers felt that the NFM significantly overstated Genentech’s prospects with respect
to pipeline productivity, development costs, subsequent applications of Avastin (Genentech’s
most valuable drug), the tax rate, and other operating assumptions. In their opinion it was not a
reasonable valuation. They said that the NFM was biased and that the LRP was more

The Collapse of the Financial System from September 2008–January 2009

 Financial Crisis happened (details p.10-11)

 The demand for life-saving drugs was not cyclical, so Roche and Genentech’s revenues were not
much affected, but their share prices dropped.
 The bigger problem was that Roche wanted to finance the acquisition partly with debt, and
banks were not lending much (or loans would be expensive) at that moment because of the
 They talked to some banks but until end of January 2009, Roche still didn’t obtain nor ask for
any financing commitments. They first wanted to reach an agreement with Genentech before
making a financing agreement.

The Decision Facing Humer

 In January 2009 Roche’s and Genentech’s advisors met to discuss the points of disagreement in
the NFM, but Genentech refused to revise them.
 They reached an impasse and Roche’s CEO Humer faced three alternatives:
(1) concede and bring the price closer to $112 (f.ex. $100). But it wasn’t sure that Genentech
would accept, especially since they had been very stubborn.
(2) He could make a tender offer, which would take the issue of valuation directly to
Genentech’s shareholders, bypassing the board and the special committee, although the
committee would have to issue a recommendation within 10 days of the offer. However, this
could be seen as a hostile move and cause opposition among Genentech’s managers and
employees. If this would fail, another attempt at an acquisition in the future would be even
harder. Plus, a lot of shareholders of Genentech were very loyal and believed that their shares
were worth much more than the market price, so Roche would have to convince every single
shareholder to accept the tender offer, which would be difficult.
(3) He could just wait. One of Genentech’s projects, a cancer drug (Avastin) was being tested
and the results would be announced soon. Negative results could reduce uncertainty as to
Genentech’s future performance and might bring Roche’s and the special committee’s
valuations closer together. However, a positive result would lead to a positive impact on the
stock price, making the acquisition even more expensive and potentially out of reach from a
financing perspective.
 Humer wondered what his next steps should be. How could he bring Roche’s acquisition of
Genentech to a successful conclusion?