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Seminar assignments - Roche case

Advanced Corporate Finance (Universiteit van Amsterdam)

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Advanced Corporate Finance

Roche’s Acquisition of Genentech

1. Why is Roche seeking to acquire the 44% of Genentech if it already owns the
rest? What would be the benefits and risks to Roche from owning 100% of
Genentech?

In first instance, it was a good move to acquire part of Genentech, as this company was a
“trailblazer” in biotechnology, which sector was rather small and not very mature, but
growing a lot faster than for example pharmaceuticals. Genentech’s share price rose
from the first moment they went public.
Genentech became a vertically integrated pharmaceuticals company, which researches,
produces and sells their products in the US. It is very beneficial for Roche to use the
same sources for her own products in the US.
In 2008 Genentech already counted for 24% of Roche’s pharmaceutical product sales.
Therefore, it’s obvious Roche would not like to lose any power in this alliance, as this is a
relevant source of income.
Furthermore, the product licensing agreement that Roche owned, would expire in 2015.
After 2015 they won’t have the right to opt in to development and to commercialize
Genentech products outside of the US anymore. There would need to come a new
agreement, which could be sold to the highest bidder. This could also be between
competitors, in which case Roche would lose the ownership.

By this acquisition, Genentech’s research and development costs were financed by

Roche, which led to the fact that it could exploit even more.

Roche already owned more than half of all the shares and had a majority in the board.
This meant that the Roche directors had to give their approval before Genentech made
certain decisions.
By owning 100% of Genentech, Roche could decide on all the important issues herself
and Genentech would not have a relevant power to come up with ideas that would
benefit only Genentech itself.

Genentech was a fast-growing company, which at some point came into direct
competition with Roche in some markets in the US. There was more and more overlap
and duplication between the two firms. Therefore, it’s a good move to acquire
Genentech, to prevent the sales of Roche’s products to drop. It also gives more
opportunities to collaborate, as to become a relevant player in many sectors on
worldwide scale.

Roche didn’t have access to the property rights of Genentech. This led to an information
barrier between researchers of the two companies, which could be solved by merging
the companies. This might be very beneficial for the joint product development and
research.

By this 100% acquisition, the two companies need to merge. So the employees of
Genentech, a strong-cultured company, that did not really notice their company was

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partly owned by Roche, might oppose this acquisition. The purchase of Genentech could
lead to scientists leaving the company, as they were afraid Genentech’s independence
would be lost.

Furthermore, Genentech feared that their research and development would not stay
unique and innovative. This could lead to some problems between the two firms, as
there was a conflict of interest between them. Roche only wishes to make the costs
efficient and make more profit out of the merged company, while Genentech wants to
hold its independence.

So, there could be done a lot of cost cutting by merging the companies. There are a lot of
facilities at the two companies that are overlapping each other. From exhibit 9, we see
that there could be made 750 to 850 mln of savings per year in a period of 5 years.

Another advantage to Roche by merging with Genentech would be that it would get
access to Genentech’s cash, which was building up as it did not pay out any dividends.
This gives many new investment and research and development opportunities for Roche.
As can be seen in exhibit 7, the cash and marketable securities of Genentech were 9.5
billion dollars in 2008.

2. As of June 2008, Genentech held approximately $7 billion in cash, including

short-term investments and securities not needed for daily operations. What is
a reasonable range for the standalone value of Genentech in June 2008? (Note:
it is recommended you use both DCF analysis and valuation by comparables).

Discounted Cash Flow analysis:

For this analysis we need to take the future cash flows and they need to be discounted to
the present value. Since the standalone value is asked for June 2008, we need to use the
information from the June Long-Range Plan. This plan states that until 2018 the free
cash flows will grow with 7% per year and in the years after that it will grow with 2%
per year. A WACC of 9% is used. To calculate the value of Genentech of 2008 we need the
FCF of 2009 which is $ 3,113 million. First we need to calculate the present value of the
cash flows from 2008 until 2018:

10
3,113 1.07
0.09−0.02 ( ( ))
× 1−
1.09
=$ 26,313.256 mln

Now we will calculate the present value of the cash flows after 2018, this cash flow
grows at a rate of 2% forever. We calculate the present value for 2018 and then we
discount it for 2008:
10
3,113 ×1.07
0.09−0.02
9
=$ 40,279.157 mln
1.09

The enterprise value using the discounted cash flow method is

26,313.256+40,279.157=$ 66,592.413 mln

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Valuation by comparables:
A different way of calculating an appropriate enterprise value of Genentech is to
compare it to similar companies. We are going to compare Genentech to the six
companies listed in exhibit 13, which are companies in the same line of business as
Genentech. The companies will be compared on the basis of the multiples of the
enterprise value/revenue ratio, EBITDA, price/earnings ratio and PEG ratio.

EV/revenue ratio:
The mean multiple of this ratio of the six companies is 6.7. If we multiply this by the
revenue of Genentech in 2008 we get the enterprise value for that year:

EV =13,418 ×6,7=$ 89,900.6 mln

EBITDA:
We don’t know the EBITDA, but the EBIT is given in exhibit 3 and if we add the
depreciation and amortization from exhibit 10 we get EBITDA. 5,431+ 592=6,023 mln .
To calculate the enterprise value we multiply the EBITDA by the multiple from exhibit
13:
6,023 ×16.7=100,584.1mln

Price/earnings ratio:
To calculate the market value using the price/earnings ratio we first need to calculate
the earnings per share and then use the mean multiple of this ratio to calculate the new
price per share.
net income 3,427
earnings per share= = =$ 3.2545
shares outstandi ng 1,053

new share price=3.2545 ×24.1=$ 78.43345

MV =78.43345× 1.053=$ 82,590.422mln

To get the enterprise value we add total liabilities(exhibit 4) en subtract cash held by the
company: EV =82,590.422+6,116−7,000=$ 81,706.422 .

PEG:
The PEG ratio is the price/earnings to growth ratio and if a company is fairly valued this
ratio will be 1. In this comparison the PEG ratio is 1.2 which means that the Genentech
stock is overvalued. The price of shares increases more than the earnings per share.
First we multiply the multiple of the PEG ratio with the multiple of the price/earnings
ratio and we multiply with the earnings per share already calculated above. That will
give us the new share price: 1.2× 24.1× 3.2545=$ 94.12 . The market value of
Genentech is 94.12 ×1,053=$ 99,108.36 mln .

Just as with the price/earnings ratio the enterprise value is the market value plus
liabilities minus cash: EV =99,108.36+6,116−7,000=$ 98,224.36 mln .

From these two methods of estimating a reasonable enterprise value we can say that a
good range is a value between $ 66.592,413 mln and $ 100,584.1 mln.

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3. As of June 2008, Genentech has 1,052 million shares outstanding. Using a 9%

WACC, what is the value of the synergies Roche anticipates from this takeover? How
sensitive are your estimates to this WACC value?

Here we have an exact copy of Exhibit 9, which shows the estimates of achievable
synergies by expense category and year (in millions of US$).

Year 2009 2010 2011 2012 2013 & % Dependent

after with merger
Manufacturing 0 102 205 256 270 50.00%
Research 44 114 118 121 125 0.00%
Development 38 98 109 111 112 100.00%
Marketing 38 98 101 104 107 100.00%
Roche G&A 63 103 113 123 124 75.00%
Genentech G&A 40 103 106 109 113 37.00%
TOTAL 223 618 752 824 851

We can correct Exhibit 9 in such a way, that we can find the total relevant synergy
number by year, the 'real synergies'.

Year 2009 2010 2011 2012 2013 & after

Manufacturing 0*0.5 = 0 102*0.5 = 51 205*0.5 = 102.5 256*0.5 = 128 270*0.5 = 135
Research 44*0 = 0 114*0 = 0 118*0 = 0 121*0 = 0 125*0 = 0
Development 38*1 = 38 98*1 = 98 109*1 = 109 111*1 = 111 112*1 = 112
Marketing 38*1 = 38 98*1 = 98 101*1 = 101 104*1 = 104 107*1 = 107
Roche G&A 63*0.75 = 47.25 103*0.75 = 77.25 113*0.75 = 84.75 123*0.75 = 92.25 124*0.75 = 93
Genentech G&A 40*0.37 = 14.8 103*0.37 = 38.11 106*0.37 = 39.22 109*0.37 = 40.33 113*0.37 = 41.81
TOTAL 138.05 362.36 436.47 475.58 488.81

According to the case: 'Given the forecast based on the June LRP, Greenhill used a 9%
weighted average cost of capital and a 2% long-term growth rate.' Now we can calculate
its present value. We will see '2013 & after' as a perpetuity.

Present value of real synergies:

138.05 362.36 436.47 475.58 488.81/( 0.09−0.02)

+ + + + =$ 5,644.06 mln For the
1.09 1.092 1.093 1.09 4 1.095
sensitivity analysis regarding the WACC value, we will use the values 7%, 7.5%, 8%,
8.5%, 9.5%, 10%, 10.5%, 11%.

Present value of real synergies using 7%:

138.05 362.36 436.47 475.58 488.81/(0.07−0.02)

+ + + + =$ 8,134.92mln
1.07 1.072 1.073 1.07 4 1.075

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Present value of real synergies using 7.5%:

138.05 362.36 436.47 475.58 488.81/( 0.075−0.02)

+ + + + =$ 7,340.07 mln
1.075 1.0752 1.0753 1.075 4 1.0755

Present value of real synergies using 8%:

138.05 362.36 436.47 475.58 488.81/( 0.08−0.02)

+ + + + =$ 6,679.14 mln
1.08 1.082 1.083 1.08 4 1.085

Present value of real synergies using 8.5%:

138.05 362.36 436.47 475.58 488.81/(0.085−0.02)

+ + + + =$ 6,121.17 mln
1.085 1.0852 1.0853 1.085 4 1.0855

Present value of real synergies using 9.5%:

138.05 362.36 436.47 475.58 488.81/(0.095−0.02)

+ + + + =$ 5,231.6 mln
1.095 1.0952 1.0953 1.095 4 1.0955

Present value of real synergies using 10%:

138.05 362.36 436.47 475.58 488.81/(0.1−0.02)

+ + + + =$ 4,871.63mln
1.1 1.12 1.13 1.1 4 1.15

Present value of real synergies using 10.5%:

138.05 362.36 436.47 475.58 488.81/(0.105−0.02)

+ + + + =$ 4,554.86 mln
1.105 1.1052 1.1053 1.105 4 1.1055

Present value of real synergies using 11%:

138.05 362.36 436.47 475.58 488.81/(0.11−0.02)

+ + + + =$ 4,274.06 ml n
1.11 1.112 1.11 3 1.114 1.115

When the estimations regarding the different cost of capitals would contain errors, or
when the variance in the future cost of capital simply goes the wrong way, we see that
some huge differences in the present value of the real synergies exist. A wrong
estimation of just 0.5 percent point could already lead to a ($6121.17- $5644.06) = +
$477.11 million or ($5231.6 - $5644.06) = -$412.46 million difference. Therefore it
could be said that the synergy is very sensitive to differences in the WACC.

4. What should Franz Humer do? Should he launch a tender offer for Genentech's
dispersed shares and at what price? How should this offer be financed?

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In August 2008 Genentech refused Roche’s acquisition offer of $ 89 per share. However,
it would be a good move to let the acquisition succeed, as can be seen in question 1.

The two companies came into direct competition with each other at a certain point,
whilst getting more and more duplication of effort and facilities between the two of
them. Besides this, the information barrier between them could be solved, and therefore
the joint product development and research could become better. Therefore, merging the
companies could benefit both of the companies. And a big advantage for Roche would be
the fact that they would get hold of Genentech’s cash, which could give them a lot of
investment opportunities.

Furthermore, the product licensing agreement that Roche owned, would expire in 2015
anyway, so by acquiring Genentech, they could hold the right to sell and expand
Genentech’s products outside the U.S.

Therefore, a tender offer should be made again for Genentech’s dispersed shares to lead
the acquisition to a successful conclusion. A friendly offer didn’t work, so this offer can
be seen as an unfriendly tender offer.
However, this might have some risks. Genentech could for example try to resist. This
could be very unfavorable for the negotiations about the share price. There might be
some resistance of the employees, which can lead to the fact that intellectual scientist
leave the company.

The most recent share price of Genentech is $ 81.82 (exhibit 13). When the two firms
merge, synergy is created and this should be added to the current share price to find the
price Roche should pay per share.
5,644,06
premium( synergy per share)= =$ 5.36
1,053

81.82+5.36=$ 87.18

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