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— Analysis —
Roche has long held the right to snap up the rest of Genentech, but it has chosen to let the biotech pioneer operate at arm's length to keep its lucrative research engine humming. But the tenor and terms of the $89-per-share offer, only a 9% premium, took the industry by surprise. On Aug. 13, Genentech's three independent board members rejected that bid, as expected, but said they would consider a higher offer.
The offer leaves room to wonder whether, instead of the likely
absorption of Genentech into the 80,000-person Roche, there might be
more surprises ahead. The suspense stems in large part from the
documents that govern the firms' relationship. They give Roche the
option to take its bid directly to minority shareholders if it can't
come to terms with Genentech's board, which on July 24 said there was
"no assurance" of reaching a deal with Roche. But those nearly
10-year-old documents contain enough vagueness to plant seeds of doubt.
"The agreement is scant on details and seems to refute what Genentech
is saying in public," says Cowen and Co. LLC analyst Eric Schmidt. "It's like showing up at the poker table and not knowing the rules."
Perhaps the biggest bombshell in the companies' relations came in 1990, when they negotiated in secret Roche's $2.1 billion purchase of 60% of Genentech. Genentech had two marketed products at the time, a treatment for acute heart attacks and a bioengineered human growth hormone, and earned $44 million on $400 million in revenue in 1989, with 40% plowed back into R&D. But its stock, which debuted in 1980, was depressed, and officials feared Wall Street would force the firm to trim research and focus on profits. The solution was to find a benign buyer that would leave Genentech's researchers in peace. With veteran healthcare banker Fred Frank, then at Shearson Lehman Hutton Inc., as the go-between, only a select few at Roche and Genentech began the discussions. They started out literally with a shock: As Frank and Genentech executives gathered in New York in October 1989 to make their first trip to Switzerland, the 6.9 magnitude Loma Prieta earthquake struck the San Francisco Bay Area. After several frantic calls, they learned Genentech's bayside campus and facilities, not to mention their own families, were fine and proceeded with the trip. "We didn't want it to be an auction," recalled venture capitalist Thomas Perkins in a 2001 interview that was part of a University of California oral history project. Perkins was an original investor, was chairman from 1976 to 1990 and kept a board seat until 1995. "There was fear that somebody could have taken over Genentech and simply milk what already existed ... getting the patents, getting the royalty stream, getting the existing products and dispensing with its future. We were confident Roche wouldn't do that." Still, shareholders were furious, shunted into a minority position, and the firm lost its halo of complete independence. "It [was] still an independent company, more or less," said Perkins. "But it [was] no longer the baby Jesus." The keystone to the deal's architecture was a redeemable common share that allowed Roche a "call" option to buy the rest of Genentech at any time in the next five years at escalating prices from $38 to $60 a share. The announcement of the deal in February 1990 also brought a new CEO, G. Kirk Raab. Co-founder Robert Swanson took the board chair and ceded the daily reins to Raab, and not without some friction. When Swanson brought Raab on board in 1985 from Abbott Laboratories his executives told him Raab one day would want Swanson's job. In 1995, Raab and Swanson went back to Roche as its deadline approached to discuss an extension. Roche's call option would continue until mid-1999, with the call price stepping up in regular increments until it reached $82.50. To agree to the extension, Roche gained the right of first refusal to all Genentech drugs outside the U.S., a windfall that now extends until 2015. Genentech products, including those sold by Genentech in the U.S., accounted for 50% of Roche's worldwide drug sales of $17.3 billion in the first half of 2008. They also negotiated a floor -- a "put" that would allow non-Roche shareholders to sell their Genentech shares back to Roche at $60 in case Roche ultimately punted on its call options and the stock tanked. The extended deal with its new collar effectively turned Genentech stock, with its signature DNA symbol, into a bond, and many analysts stopped following the company. Shareholder lawsuits followed. Collecting documents to defend against the litigation, a Genentech legal team found a note from Raab to Roche officials, asking them during the negotiations to countersign a $2 million personal loan. (Roche refused.) When the note surfaced, Raab was immediately fired. Raab's departure opened the door for Art Levinson to become CEO. Levinson had a history of breakthrough research on mammalian cell culture and, at a previous stint in the University of California at San Francisco lab of Nobel Prize winner Harold Varmus, cancer-causing genes. As he climbed the ladder, Levinson had developed a good reputation with his fellow researchers, such as Larry Lasky, a self-described anti-authoritarian who worked on vaccines at Genentech and eventually earned the honor of Genentech Fellow. "Art was a scientist [and] was very good at arguing for his scientists," Lasky said in a 2003 interview. "He would show his scientists off to [CEO] Kirk [Raab] when he was VP of research. He wanted Kirk to know that he had a bunch of smart guys here, and they should be rewarded. I have to admit I have a lot of respect and thanks to Art for doing that." Levinson used that political capital to rally the company as the next Roche deadline approached in June 1999. The firm's new focus on monoclonal antibodies that fight cancer, in hindsight a brilliant tack, was then fraught with risk. Under the mantra "Beat the Put," Levinson urged the firm to push its stock price as high as possible in order to discourage a takeover. With the stock actually topping the $82.50 mark in the run-up to the deadline -- it hit $90 on May 6 -- opinion split on what Roche would do. On June 2, Roche pulled a rabbit out of its hat. To the chagrin of investors who had bet otherwise, Roche exercised its option at $82.50. But it also announced it would refloat a percentage of Genentech shares to the public. Levinson said at the time, "To some extent we were an arbitrage play between those who believed Roche would exercise its call and those who believed Roche would not." Genentech was born again as a public firm, but the new deal gave Roche more power over the board and a more favorable opt-in structure on Genentech's drugs. The IPO priced at $97. Post-IPO shares opened July 20 at $118 and kept going up, Roche selling additional shares all the while. Between the IPO and two follow-on sales, Roche brought in nearly $8 billion. That was great for Roche, not so great for other Genentech investors. "It caused all the stockholders to sell their shares at [$82.50] and pay capital gains," recalled Dennis Kleid, a Genentech scientist-turned-patent-expert, in a 2002 interview with the University of California project. Roche is now saying publicly what it said in 1990: Preserving Genentech's culture of innovative research is a priority. But this time Roche is also talking consolidation of back-office and administrative functions, clinical development and a shuffle of Roche's U.S. employees, some to Genentech's South San Francisco, Calif., campus, which would become Roche's de facto U.S. headquarters. No matter what, there will be disruption. That scenario, plus the hard edge to Roche's low-ball offer that some former Genentech executives found insulting to Levinson, might have pushed the relationship beyond repair. Five years ago, former top scientist Lasky said, "I guarantee you ... Genentech will always be there." Unless the companies can surprise us one more time with a deal that keeps Roche hands-off and Genentech's best and brightest on board, it probably won't be the Genentech that Lasky or any other alumni would recognize. |
If there's one recurring theme in the nearly 20 years of intertwined history between Roche Holding AG and Genentech Inc., it's the element of surprise. The most recent stunner came July 21, when majority owner 
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