Genentech-Roche Deal Shows Attraction Of Biotech Assets

Genentech Inc.'s (DNA) ability to leverage a higher price tag from Roche Holding AG (RHHBY) in an otherwise downtrodden market demonstrates the attractiveness of biotech assets, especially for the right buyer.

However, it remains to be seen if the deal - and its hefty valuation - will prompt additional large biotech acquisitions, even at a time when the health-care industry is remaking itself in the face of government-led changes. In the mean time, smaller and cheaper biotech purchases remain more likely.

Biotech drugs are attractive because they have better margins generally and, currently, no method for generic threat. In addition, biotech companies have unique expertise and facilities, making it tough for others to invade their turf.

As a result, the more successful biotech companies carry large market caps and still-healthy valuations. The industry's advantages are likely why investors may be leaving Genentech shares in the hands of arbitrage traders and putting their money to work in other areas of sector, prompting a 5.6% gain in the Amex Biotechnology Index.

Traditional pharmaceutical companies, most of which are ailing from poor pipelines and generic competition, are turning increasingly to biotech drugs; however, most of Big Pharma's moves have been limited to licensing agreements or acquisitions of smaller biotech companies.

Roche's large purchase of Genentech goes against that trend, but the Swiss giant had a discernible advantage - it already owned 56% of Genentech. That enabled Roche to buy the rest of Genentech for "only" $46.8 billion.

If Roche had to buy all the shares outstanding, the total purchase price would have been around $100 billion, assuming it would have been able to get Genentech to agree to $95 a share without having the advantage of already being the majority owner.

While the price of $95 a share offers only a 16% premium to Genentech's price before Roche's initial July offer, it commands a price-to-earnings multiple of about 25 times the South San Franscisco-based company's projected 2009 earnings. In comparison, biotech bellweathers Amgen Inc. (AMGN), Biogen Idec Inc. (BIIB) and Genzyme Corp. (GENZ) trade at between 10.5 and 12 times 2009 earnings estimates.

In addition, Roche's willingness to raise its original offer by 6.7% - over a time frame in which the S&P 500 fell 43% and the Amex Biotechnology Index lost 30% - indicates the value biotechs maintain.

Because of Genentech's strong price tag, biotech stocks rose Thursday. One of the biggest gainers being Celgene Corp. (CELG), up 12% to $47.17. Celgene has strong products in the blood-cancer drug Revlimid and the blood-disorder treatment Vidaza, and an intriguing pipeline.

Despite its attractive portfolio, Celgene also comes with significant hurdle - its market cap of $21.6 billion. That means a deal with a 40% premium, not uncommon in biotech acquisitions, would put the price tag at $30 billion. A deal at half the premium still would be about $26 billion.

That's a lot for any buyer to swallow and why Big Pharma, which can afford such deals, has preferred more modest biotech deals, such as AstraZeneca PLC (AZN) buying MedImmune for $15.6 billion or Eli Lilly & Co.'s (LLY) $6.5 billion acquisition of Imclone Systems Inc.

When Big Pharma is ready to spend big, they have stayed within the family, such as Pfizer Inc. (PFE)/Wyeth (WYE) and Merck & Co. (MRK)/Schering-Plough Corp. (SGP). In those cases, the acquiring company can leverage more natural synergies and big job cuts to produce profits from the deal faster.

Nonetheless, interest in acquiring biotech assets appears to be rising. Last year, according to Dealogic, the amount spent purchasing biomedical and genetic companies totaled $68.4 billion, matching the amount spent on the group during the decade's first eight years and roughly equal to the total spent on pharmaceutical purchases, marking the first year those figures were on similar levels.

Analysts say that among large biotechs, the most likely takeover targets are Amgen, which has a market cap of $51 billion, or, more reasonably priced, Biogen and its $14.5 billion market cap.

The busier biotech market is likely to be for smaller companies suffering from depressed values and the difficult finding environment. Cowen & Co analyst Eric Schmidt names Acorda Therapeutics Inc. (ACOR), Cougar Biotechnology Inc. (CGRB) and Cadence Pharmaceuticals Inc. (CADX) as possible targets because they offer products in late-stage development and the buyer may have some negotiating leverage.

"Those are clearly the types of companies that large pharma and biotech have found attractive in the past," he said.

-Thomas Gryta, Dow Jones Newswires; 201-938-2053; [e-mail]