Genentech to Extend Pact With Roche
Swiss Firm's Option to Buy Final 34% to Run to '99; Some Holders Vow Fight
By Charles McCoy

05/02/1995 The Wall Street Journal Page B6

SOUTH SAN FRANCISCO, Calif. -- Genentech Corp. agreed to revise and extend Roche Holding Ltd.'s option to buy the rest of the company, an accord that some investors vowed to block.

Roche's option, which was set to expire June 30, would have enabled the Swiss-based pharmaceutical concern to acquire the 34% of Genentech it doesn't already own for $60 a share, or roughly $3 billion.

Under the complex new agreement, Roche has the option to buy the remaining Genentech shares for prices that could go as high as $82 a share. In addition, if Roche decides not to exercise the option during its four-year term, Genentech shareholders can require Roche to buy the shares at $60 each. The new arrangement also commits Roche to fund large amounts of the development costs for Genentech products, but only if it decides to license the products.

The unusual agreement baffled and angered some investors. Basically, for motives that aren't clear, Roche wants to put off an investment of $3 billion for as much as four years. Excluding whatever it pays for development costs of licensed drugs, Roche could wind up paying nothing for the privilege. The maximum it would pay would be development costs plus 9% a year in increased costs for exercising its purchase option. Some investors said the $82-a-share target price for 1999 is too cheap for a biotechnology powerhouse like Genentech, which has a string of promising drugs in the pipeline to support its profitable mainstay, anti-blood-clotting drug TPA.

Indeed, compared with Genentech's stock price last week, the $60-a-share price Roche would have to pay if it doesn't exercise the new option would only provide a return over four years of about 5% annually. "Biotech investors look for a lot better returns than that," said David Molowa, an analyst with Bear Stearns.

Such concerns drove down Genentech's stock, which fell $2.50, or 5%, to close at $47.875 a share in New York Stock Exchange composite trading yesterday. Moreover, several institutional investors expressed dismay over the plan, and said they would vote to kill it. The plan requires approval from holders of half the shares not owned by Roche; Roche can't vote on the plan.

Karen Firestone, a portfolio manager at Fidelity Investments, which owns more than a million Genentech shares, said that, under the circumstances, management "did what is best to preserve the stock price." Other institutional holders were harshly critical.

Roche, a giant Swiss drug company, acquired the original option when it bought 60% of Genentech in 1990 for $2.1 billion and has since boosted its stake through open-market purchases.

Yesterday, both Roche and Genentech asserted that Roche had determined it didn't want to exercise the option because of concerns about what impact a complete takeover would have now on Genentech's freewheeling, independent culture, and on its ability to retain and entice top scientists with stock options. Roche isn't known for being as generous with stock options and incentives as Genentech, where many young scientists have become millionaires as a result of such programs.

"Genentech is an unusual place, and Roche's goal and ours is to make sure it stays the same place," said G. Kirk Raab, Genentech's chief executive officer. Another factor, according to a top Genentech scientist: Genentech scientists have been unnerved by big layoffs at Syntex Corp. since Roche took it over last year. It's unclear why scientists' attitudes won't still be a problem in four years, but Mr. Raab insisted that Roche's reluctance to exercise the option didn't signal any cold feet about the relationship between the two companies. "If anything, the [new deal] makes the relationship stronger," he said.

But some analysts questioned that, and noted that, with Genentech shares trading in the $45 to $50 a share range, Roche might have found the $60-a-share option price too steep. Some analysts also speculated that Roche may have been concerned by a U.S. Food and Drug Administration investigation into Genentech's marketing practices, some of which have been criticized for being overaggressive. Moreover, some analysts noted that Roche already has its hands full with the digestion of Syntex and a global restructuring that has forced thousands of layoffs at Roche operations. "Roche doesn't need the turmoil of another big acquisition right now," said Mark J. Simon, a managing director of Robertson Stephens Inc.

Roche officials couldn't be reached for comment.

In any case, with Roche apparently unprepared to exercise the option, Genentech faced the possibility that its stock would swoon and that management would be forced to generate consistent, higher earnings to appease Wall Street. That, analysts said, could have been tough on Genentech, because the giant research and development costs and hit-and-miss nature of biotech make producing consistent profits difficult.

"They feared having no earnings and having the stock at $40 a share," said Samuel D. Isaly, an analyst at Mehta & Isaly, which specializes in biotech-company research. The new arrangement with Roche frees Genentech from those concerns, but "to put it unkindly, it's a wimp's deal," Mr. Isaly said. Bear Stearns's Mr. Molowa said the agreement "could have been worse, but current shareholders really get shortchanged."

Even though it has put off fully acquiring Genentech, Roche seemed to signal that its interest remains strong. Roche agreed to fund half of the development costs of any U.S. products it licenses, and all such costs in non-U.S. markets. Mr. Raab said that would save Genentech "hundreds of millions" of dollars. Roche also gets a 10-year option on Genentech products outside the U.S.; Mr. Raab said that also will save Genentech money, because it won't have to build up its own international sales organization.

Genentech spokesman Gregory Baird acknowledged that "shareholders were somewhat negative," but predicted the plan would be approved. "As the informmation is absorbed, you'll get a more long-term, stable view . . . and the deal will speak for itself," he said.