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Roche Re-Opens Bank Account: Firm Again A Creditor After Genentech Sale

Executive Summary

Roche is once again a net creditor following its most recent offering of Genentech shares, CFO Henri Meier told the company's annual earnings conference March 30 in Basel, Switzerland.

Roche is once again a net creditor following its most recent offering of Genentech shares, CFO Henri Meier told the company's annual earnings conference March 30 in Basel, Switzerland.

Roche has been a net debtor since the acquisition of Corange in 1998. During the company's earnings conference that year, Meier pointed out that the transition from a historically ample, interest-generating cash reserve to a significant debt would present a challenge to Roche in meeting its growth targets.

However, thanks to the rapid run-up in Genentech's valuation, Roche is beginning a new decade with a strong cash position despite completing three all-cash transactions (Genentech, Syntex, Corange) within 10 years.

Roche bought out the 40% of Genentech that it did not already own for $4 bil. in June. The company more than recovered that amount from two Genentech offerings in July ($2.1 bil.) and October ($2.8 bil.).

Roche ended the year with a debt of $1.9 bil. However, a $1 bil. convertible bond offering completed in January and a $2.8 bil. stock offering completed late in March moved the company's balance sheet back into the black.

The company has not yet returned to its approximately $10 bil. cash reserve prior to the Syntex deal in 1994.

The Genentech windfall also helped Roche's earnings performance for the year. The net gain on the Genentech transactions in 1999 allowed Roche to report operating earnings of $4.11 bil. (up 46.9%) and net income of $3.7 bil., up 31.2%. Excluding the Genentech transaction and other exceptional items, operating profit rose 15.9% to $3.25 bil.

Because U.S. accounting rules required Genentech to account for the cost of its buyout, the biotech company posted a net loss in 1999 despite a 50% rise in sales.

Roche's decision to cash in some of its holdings in Genentech lends itself to two interpretations: (1) a comment by Roche on the current valuation of biotech stocks in the U.S.; and (2) a comment about Roche's confidence in meeting earnings targets in the near term based solely on product performance.

The Genentech transactions unquestionably represent savvy financial management by Roche in capitalizing on the enthusiasm for biotech stocks on Wall Street.

Meier noted that over the past 18 months large biotech companies have quadrupled in value while pharma companies have remained flat. Genentech's valuation before the June buyout was capped, in effect, by Roche's pre-set option price.

Even putting aside the impact of Genentech's pipeline on Roche's product line over the past 10 years, Roche's relationship with its biotech affiliate has been extraordinarily profitable.

The total cost to Roche of its phased buyout of Genentech was $6.8 bil.: $2.1 bil. for 60% of the company in 1990, $700 mil. in open market purchases over the next eight years, and $4 bil. to buy out the remaining portion in June 1999.

From that $6.8 bil. investment, Roche has grossed $8.7 bil. from the three stock offerings and one bond offering over the past year, for a profit of $1.9 bil. Roche retains a controlling interest in Genentech (just under 60%), currently valued at almost $25 bil.

After reviewing the performance of Roche's investment in Genentech, Meier made an understated observation: "Roche has enjoyed a reputation for knowing how to handle acquisitions successfully."

The timing of the cash infusion works well for Roche in the short term. The company is facing a potentially difficult 2000, with the anesthetic Versed/Dormicum expected to face generic competition following the expiration of its U.S. patent June 20.

Sales of Versed for 1999 were $539 mil., up 11% in local currency. The product represents about 5% of Roche's global pharma sales, but a larger share in the U.S.

The elimination of interest payments as a result of moving out of debt will help the company meet earnings targets if product growth alone is not sufficient.

Roche has another cushion to draw on to shore up earnings in the near term: CEO Franz Humer reported that although the integration of Corange has been fully costed, the expected synergies are still not complete. Annual cost savings had been projected at $640 mil. at the time of the merger but only $515 mil. have been achieved so far. The full value will be realized next year, Humer said.

Transfers of production have taken longer than expected because of authorization and licensing delays, Humer said. Corange's Boehringer Mannheim had a considerable diagnostics sales force that has not been fully integrated within Roche Diagnostics yet, and more synergies are expected, particularly in PCR sales.

The company is emphasizing the relative strength of its new product line heading into the Versed patent expiration. Humer reported that less than 15% of 1999 sales came from products that face patent expiration in the next five years.

Prescription medicines that have been on the market for less than five years accounted for 21% of pharmaceutical sales in 1999, up from 12% in 1998.

Two products introduced into the primary care marketplace in the last year contributed to the rise. The anti-obesity drug Xenical (orlistat) had sales of CHF 940 mil. ($604 mil.) in 1999, and was only introduced into the U.S. market in May. The Gilead/Roche anti-influenza product Tamiflu (oseltamivir) posted sales of CHF 60 mil. ($39 mil.) after introduction into the U.S. market in November.

The company has introduced 10 new products or indications in the last two years, Humer reported. These include two Genentech cancer therapies co-promoted by Roche, Herceptin (trastuzumab) ($193 mil. in 1999 sales) and Rituxan/MabThera (rituxumab) ($315 mil.).

Roche gave a conservative sales estimates for Xenical in 2000 of above CHF 1 bil. ($650 mil.), noting that the initial launch was beyond expectations. Roche is understood to have an internal sales target of $750 mil. for the product.

Thirty-five percent of U.S. insurance companies reimburse for Xenical, Humer reported, up from 20% at launch. Roche continues to work on increasing the reimbursement rate in the U.S. and in other countries.

An indication for long-term treatment of type 2 diabetes is targeted for a late 2001 sNDA filing. A diabetes indication will presumably trigger coverage by payors that routinely exclude obesity products.

The U.S. launches of Xenical and Tamiflu were supported by primary care sales force expansions and spending on direct-to-consumer advertising campaigns. The U.S. sales force is now at about 3,000 reps, up from about 1,200 three years ago, Humer said, noting the need for more reps for primary care details.

DTC ads for Xenical began in October, but the company has switched from a "product-and-use" campaign to a campaign based on separate branded reminder ads and unbranded "see-your-doctor" ads (1 (Also see "Roche Xenical TV Ads Shifting Focus; Side Effect Info Weighs Down Message" - Pink Sheet, 6 Mar, 2000.)).

Roche has found that unbranded ads telling patients that obesity is a medical condition and advising them to talk to their doctor have been the most successful, Humer reported. The unbranded ads do not undergo the same scrutiny of content for fair balance by FDA, and are less confusing to the patient, Humer said, yet they still result in 800,000 to 1.1 mil. visits per month to the company's obesity web site.

Humer credited the promotions with increasing weekly new prescriptions by 17%-23% and achieving a 65% repeat prescription rate.

The pharma division had sales of CHF 16.49 bil. ($10.59 bil.), a rise of 15%. Operating profit was up 16% to $2.25 bil., with an operating margin of 21%.

Roche overall posted sales of $17.71 bil., a gain of 12%. Net income before exceptional items rose 15% to $3.23 bil. Exceptional items, a net gain of $470 mil., included the Genentech transactions as well as payments relating to vitamin price-fixing charges and a patent suit against Genentech by UCSF.

A $222 mil. charge was taken regarding the human growth hormone patent suit; $150 mil. was paid to UCSF in the fourth quarter.

Regarding vitamins, a $500 mil. fine was paid and $632 mil. has been earmarked for a U.S. class action settlement. Humer noted that on March 28 the judge mediating the settlement agreed that the amount was fair. A roughly $430 mil. charge was taken in 1999 regarding future settlements in other countries. No charges are anticipated in 2000, Meier said.

Roche has made management changes in the vitamins and fine chemicals division and held a company-wide program on competition and corporate principles, Humer reported. An internal auditing unit was established to ensure adherence.

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