Roche Blinks But Is $93 Enough For Genentech Shareholders?

The $6.50 per share increase in Roche’s offer also includes an extension of the tender deadline to March 20.

Is $93 the magic number?

Just days before its hostile tender offer for Genentech was scheduled to expire, Roche increased its bid for the iconic biotech from $86.50 a share to $93 on March 6. The move is the latest twist in a long-running poker match between the two companies.

While it's far from clear whether the additional $6.50 a share - which raises the acquisition price from $42 billion to nearly $46 billion - will be enough to sway minority shareholders to Roche's cause, consensus opinion is that the offer is fair, especially given the current economic climate.

The higher offer, which also calls for extending the proposed tender deadline from March 12 to March 20, quickly caused Genentech stock to spike 10 percent.

"The chances for success are much higher now," Raymond Christopher, an analyst at RW Baird, wrote in an investor note. "While we do not think it is a slam dunk the deal gets done at $93, we think Roche's chances for a 90 percent tender are much better now - likely as high as 75 percent."

Other analysts are even more bullish on the likelihood of a deal at the current price. "We believe that minority shareholders will view this as a fair price for the company and will now tender their shares," wrote senior biotechnology analyst Christopher James in a March 6 analyst note.

A widely expected move

"Based on conversations with Genentech shareholders we believe that there is a strong sentiment to bring this process to a conclusion," Franz Humer, chairman of Roche, noted in a press release announcing the new bid.

A survey of 150 Genentech shareholders by Deutsche Bank analysts found that 71.5 percent say they will tender at least some of their shares at $93. However, a combined 42 percent indicated they would tender their stock at $97, $99 or $101. Moreover, 54.7 percent don't believe Roche's increased bid is a final offer.

Roche had little choice but to raise its offer price. As of March 5, only approximately 500,000 of the 1.05 billion outstanding shares had been tendered.

Indeed, Roche's decision to raise its bid resembles the approach it adopted last year in its takeover of Ventana Medical Systems, also a months-long endeavor in which the drug maker opted to raise its bid over a protracted period, rather than simply offer a price that was more in line with Wall Street expectations (¹ (Also see "Roche Finally Gets Nod With Sweetened $3.4 Billion Bid For Ventana" - Medtech Insight, 28 Jan, 2008.), p. 4).

There are two compelling reasons that may keep minority shareholders on the sidelines, however. First, results of a key clinical trial testing the Avastin (bevacizumab) cancer medication as a preventive therapy will be released in mid-April. If data from what's known as the C-08 trial are positive, an outcome Genentech believes has a 61 percent shot of happening, the biotech's stock price is poised to surge given the greatly expanded market for Avastin.

Language in the decade-old affiliation agreement between Roche and Genentech may also dissuade investors from tendering 100 percent of their shares. The agreement calls for two investment banks to set a fair takeover price for outstanding shares in the event that Roche obtains more than 90 percent of the minority shares outstanding. At that point, any holdouts would likely benefit because a higher price may be determined.

Still most analysts expect investors will tender some - if not all - of their shares at this higher price. "It makes the risk-reward in holding out for the adjuvant data less compelling," wrote JP Morgan analyst Geoffrey Meacham in an investor note.

"That said, we recommend that DNA shareholders tender some (~75 percent) of their shares, but not all, given our bullish stance on C-08 and the potential of a higher price (>$93) determined by investment banks if >90 percent of shares tender," he said.

A step forward for Roche

If investors heed Meacham's advice, it could make it difficult for Roche to amass the 90 percent representation it requires from minority shareholders to bring about the merger. Roche has been open about its desire to take Genentech "private" in part to extract operational efficiencies worth an estimated $750 to $850 million annually (² (Also see "After Roche/Genentech: Pharma's Focus on Efficiencies, Not Innovation" - In Vivo, 1 Jul, 2008.)).

But even if Roche fails to win at least 90 percent of the minority shareholders, Sanford Bernstein analyst Geoffrey Porges points out that the drug maker can bide its time and execute a takeover later either by purchasing additional stock or by changing the make-up of the board. "They can own 80 percent and sit and buy stock as it becomes available," he says. "This is a big step forward and they are certainly not making any headway right now."

However, he also notes the Roche bid is conditional on the results of the Avastin trial data, which means the drug maker can walk away from its bid.

"I think investors will think hard about this offer, but that fact is it remains conditional on the adjuvant data. If [the C-08 trial] fails, the bid could be withdrawn anyway. You could see some investors lock in gains at this price, but the reality is since Roche could cancel the deal, why would you bite on this? If it were unconditional, they might have gotten the deal done at this price."

Roche, meanwhile, already is paying interest on the approximately $34 billion in bonds recently issued to fund the deal. The challenge for Roche is that a higher price poses the risk of prompting ratings downgrades by Moody's and Standard & Poor's, a fact that will drive up the Swiss pharma's borrowing terms since it agreed to add an extra 0.25 percent in interest for each downgrade by the ratings agencies. Nor is the issue academic: after launching the initial bid, S&P promptly lowered Roche's rating.

Well-crafted road show carries the day

It's no secret that Roche and Genentech have widely divergent views of the biotech's valuation. SEC documents released by both companies show that Genentech might already be a Roche subsidiary were the Swiss pharma willing to accept a $112 a share price tag. Unwilling to accept such a rosy outlook, Roche responded by lowering its offer price instead (³ (Also see "Roche’s High-Stakes Gambit For Genentech" - Pink Sheet, 30 Jan, 2009.)).

It seems Severin Schwan was betting that investors would tender their shares to take advantage of a competitively priced stock in a rapidly worsening market, especially given uncertainty related to the ultimate outcome of the Avastin trial.

At the March 2 presentation, Genentech chief executive Arthur Levinson told the crowd the higher valuation is justified based on the biotech's current number of pending approvals and drugs in development, its forecasted earnings growth rates and its lack of exposure to near-term patent expirations.

"We stand by our financial forecast," he declared, "There's a significant disconnect between the (Genentech) special committee and Roche's valuation of the company."

To buttress the argument, David Ebersman, Genentech's executive vice president and chief financial officer, provided detailed yearly projections for earnings and revenue growth through 2018, with revenue reaching $17 billion by 2015. Much of that uptick will be driven by increased Avastin utilization, especially as the drug gains approval in additional indications and higher doses become the norm in treating diseases such as breast cancer (⁴ (Also see "The Genentech Sales Pitch: Higher Values R Us" - Pink Sheet, 2 Mar, 2009.)).

Next move is Genentech's

Genentech's five-hour-plus science extravaganza seems to have spurred Roche into action. It's now Genentech's turn to fold or up the ante. How the biotech responds could determine whether the negotiations turn friendly - a move that would go a long way to cement the deal. Unsurprisingly, the biotech's initial reaction was measured. In a release issued shortly after news of the sweetened offer broke, Genentech urged shareholders "to take no action at this time with respect to Roche's revised tender offer."

But the reality is many investors don't have that luxury. With the market beaten down by dire unemployment numbers and continued uncertainty in the financial sector, investors are looking for any port in the current financial maelstrom.

"I think it clearly undervalues the company, but it's meaningful," said Matt Loucks of Sit Investments Associates, who owns 350,000 Genentech shares. "In this kind of environment, it makes sense to take some money off the table."

If Genentech pays attention to those sentiments - and it has been diligent in its attentions to its investor base throughout the process - it will likely spur the special committee back to the negotiating table in the hopes of getting an even better offer.

- Ed Silverman ([email protected]) and Ellen Foster Licking ([email protected])