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Executive Summary

Genentech could have cash reserves of as high as $700 mil. to fund the next stage of its development as an upshot of Hoffmann-La Roche's $2.1 bil. offer for controlling interest in the biotech bellwether. As part of the deal to purchase a 60% controlling interest, Roche is going to put $492 mil. into Genentech's coffers for 22 mil. shares of a new issue of common stock. That investment would combine with Genentech's current $205 mil. in cash and equivalents to give the biotech business a bigger cash cushion than some of the long-established major drug companies. With $700 mil. in cash reserves, for example, Genentech would have a cash position equal to Pfizer and almost three times as large as Warner-Lambert's. Genentech found its Swiss banker in a clever merger agreement befitting the money minders of Basle and the merger mavens on Genentech's side. The California company was advised by Shearson Lehman Hutton and Wasserstein Perella. The deal will be expensive to pull off. Roche said that Genentech will take a $150 mil. charge for the costs of the transaction. As a lure to investors to give up Genentech control to Roche, the Swiss company is offering an immediate premium of 65% on the current market price of the stock for half of the holdings of existing shareholders. Roche would then set specific buyout prices for the remainder of the public holdings on an ascending sliding scale for the next four years. At the initial buyout price of $36 per share, current Genentech shareholders will get a total of $1.6 bil. for half of the roughly 90 mil. shares outstanding. There are 84 mil. shares currently outstanding, but the deal makes provision for another 6 mil. exercisable options. Roche will then invest the $492 mil. for 22 mil. shares of additional stock. That stock will be purchased at roughly the going market rate: approximately $22 per share, compared to the pre-announcement price of $21.75. According to the plan, Roche will own 60% of 112 mil. voting shares of Genentech. The biotech's board approved the deal on Feb. 2; a shareholder meeting is planned for April. When the deal is completed, current shareholders will continue to hold 45 mil. shares (40%). Those shares, however, will have de facto caps. While Roche's current premium offer and cash infusion to Genentech look generous, the company is setting limits on the appreciation of the remaining public shares of stock through the middle of 1995. After the merger, the remaining public shares of Genentech would be "converted into new Genentech redeemable common stock." That stock would be "redeemable at the option of Roche," according to a formula, through June 1995. The formula for determining the top value for Genentech stock (per share) in that period is $38 through the end of this year; $39 through the first quarter of 1991; $40 per share in the second quarter of 1991; and from then on increasing by $1.25 per share each quarter until the per share price reaches $60 in the second quarter of calendar 1995. If Roche decides to redeem, it must buy back all shares. With the added Swiss cash, Genentech would vault out of the class of new technology companies and would no longer be subject to the continual calculations of burn-rate and cash resources. The company would be protected from speculation on how long it can last until the next round of financing. Genentech was not at an obvious danger point in its growth at the time of the deal. In fact, the company was adding to its cash reserves on its own with the current successes of Protropin ($123 mil. sales in 1989) and Activase ($196 mil.). Both of Genentech's current products, however, face imminent challenges: Activase from the Eminase introduction; and Protropin from an increased attempt to break that product's orphan drug exclusivity in the U.S. Against the vagaries of the financial community's reaction to Genentech's performance and the instability of the public markets for access to capital, Genentech's ability to keep funding its development projects over a long period was problematic despite its current success. With Roche's support, Genentech could weather a drop in the fortunes of either or both of its current breadwinners. That would be a luxury in the company's decade history. Genentech Chairman Robert Swanson commented on the benefits of deep pockets. "Long-term commitment to medical research is often at odds with today's short-term investment focus," Swanson noted. "We now have the ability to build Genentech's revenues and profits by taking advantage of our abundant product pipeline." For Genentech, the agreement with Roche is a return to its commercial roots. Roche was one of Genentech's first successful partners. The two companies collaborated on the development and 1986 approval of one of the two alfa interferons (Roferon). The deal also provides a way for Genentech to progress further from the entrepeneurial stage. Swanson, the founder of the firm, will relinquish some of the hands-on control that he retains as part of the deal. Kirk Raab, the ex-Abbott senior exec, will advance from chief operating officer to chief exec. Genentech will apparently report autonomously to Basle and not through Roche Labs. However, Roche U.S. top officials were in San Francisco Feb. 2 for the announcement of the deal. Roche has said it will put two people on an expanded board. For Roche, the offer ends the speculation on where the Swiss company would turn next to expand its U.S. business. After its uninvited offer for Sterling at the beginning of 1988, Roche has been viewed as a hungry and capable purchaser. Roche was careful to point out that it was approached by Genentech for this offer. No mention of the deal was made until after Genentech board approval was an accomplished fact. The thriftiness of the Roche offer is evident by comparison with the Sterling experience. Roche backed out of the Sterling deal at about $4.5 bil. If the Swiss company decides to close out the Genentech offer in the middle of 1991, for example, it would pay a total for Genentech of between $3.8-$3.9 bil. Importantly, Roche will have the intervening 18 months to determine if Genentech's progress justifies the full price. If it doesn't, Roche doesn't have to put the extra money into the deal. Genentech meets at least two other requirements for a fit with Roche: (1) it does not directly conflict with Roche's lucrative comarketing partner Glaxo; and (2) it puts Roche back in the position of claiming to be a leader in the biotech business. At the beginning of the 1980's Roche labeled itself a "pioneer" in the new biotech business; now it will become a major banker and developer of the business in the 1990's. Roche has been very active in the AIDS and biologicals research area and there is a fit with Genentech on those interests. As recently as Jan. 30, president of the U.S. subsidiary, Irwin Lerner was part of a top industry group visiting FDA's Center for Biologics Research & Evaluation. Because much of the intrinsic value of biotech firms resides in their scientific staffs, a major challenge for Roche will be the retention of the Genentech scientific core. Roche has at least one good model (on a smaller scale) for that effort in the drug industry: Bristol's purchase of the Genetic Systems operation. Roche may be aided by the fact that Genentech will remain a public company allowing Genentech staffers to continue to feel some (though strictly limited) sense of ownership. If Genentech remains a publicly traded Roche subsidiary, it will also provide a rare opportunity for a more direct investment in a part of the Swiss operation.

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