Page 1 of 7
Case Study 1. Why is Roche seeking to acquire the 44% of Genentech it does not own? From Roche’s point of view, what are the advantages of owning 100% of Genentech? What are the risks? Roche already had 56% of shares of Genentech and now it seeks to acquire rest of the 44% shares so as to get the benefits of synergies. The pharmaceutical companies companies have been unable to introduce new products lately, and their only way to remain profitable is by mergers and acquisitions. Roche also used this method. Acquisition will help the firm compete in the market and thus will help it grow. Advantages of owning 100% of Genentech’s shares:
The merger will lead to formation of the world’s largest biotechnology company.
Value of total benefit from synergies will be $5billion. This will be a result of M&D, manufacturing, development and administrative costs reduction.
Complete ownership will give the company complete access to technology and R&D projects. It will also give the company access to its cash amounting to $9.5billion, which can also be used to make payment for debt raised for acquisition. The company can also create a contract c ontract allowing it to distribute Genentech’s best se lling
drugs. Risks of owning 100% of Genentech’s shares:
The acquired company’s minority shareholders are mostly its employees. The company’s
culture is like a family environment where all the employees work in cohesion. Acquisition may destroy this culture. The culture of Genentech will have to be matched and combined with the culture of Roche. This may create problems for the human resources which may even lead to high employee turnover.
There is a chance that the company pays higher than the premium required for the benefits of synergies. Such a situation may lead to drop in the prices of Roche’s shares. For the deal, Roche has to borrow around $30 billion. The ongoing financial crisis could make the debt financing even more difficult to obtain as well as more expensive. The contract gives Roche the right to sell Genentech on non US markets, but only till 2015. After that the company faces a high risk of losing the right.
Genentech’s cancer drug, Avastin, may not be successfully tested and may be banned
from sale. This risk of loss of revenue will also have to be borne by the company.
New competitors may come with competing best selling drugs, which will again lead to a risk of reduction in growth prospects. prospects.
Page 2 of 7 2. As a majority shareholder of Genentech, what responsibilities does Roche have to the minority shareholders? The affiliation agreement signed in 1999 stated the obligations to minority shareholders, which are as follows:
Board approval is sufficient in case of a friendly bid. Roche can buy all shares for same price
When the takeover is hostile, in which Roche would get at least 90% of shares and would hold them for at least 2 months, it will squeeze out the existing shareholders and will merge the company. It is an optional measure and not a necessary one, as per Delaware law.
As explained earlier, minority shareholders are majorly the employees of the company. It is Roche’s duty to explain the benefits of merger to them and retain them.
3. As of June 2008, what is the value of the synergies Roche anticipates from a merger with Genentech? Assess the value of synergies per share of Genentech. Please use a 9% weighted average cost of capital in your analysis. Synergies are given in an exhibit.
Value of synergies: WACC
9%
FCF
2009
2010
2011
2012
2013 and thereafter
$138.05
$362.36
$436.47
$475.58
$488.81
Terminal Value
$5,431.22
Discounted
$3,529.92
Shares
NPV
$1,423.28
Total value
$4,953.21
Shares to buy Value per share
1052 463 $10.70
2013 cash flows are treated as a perpetuity (ignoring 2% long term growth rate).
4. Based on DCF valuation techniques, what range of values is reasonable for Genentech as a stand-alone company in June 2008? Please exclude synergies from your valuation and use a 9% weighted average cost of capital. You can assume that as of the end of June 2008, Genentech held approximately $7 billion in cash, which included investments and securities that were not needed in its daily operations. (Note: Exhibit 10 is a good starting point for this analysis.
Page 3 of 7
WACC 9% Long term growth rate 2% annual growth rate 7% Analysis using DCF techniques on long range plan (LRP) Terminal value (discounted)
42,785
NPV of cash flow (2009-2018)
29,890
Enterprise value
72,676
Debt will be deducted and cash and securities will be added back to find the equity value of the firm. Enterprise value
72676
Commercial paper
-500
Long term debt
-2329
Cash and securitization
9000
Equity value
78847
Shares outstanding
1052
Value per share
74.9
Following table shows the possible values of value per share as affected by different annual and long term growth rates.
Annual/long term growth rates
1%
1.55
2%
2.50%
3%
5%
61
63
66
69
72
6%
65
67
70
73
77
7% 8%
69 73
72 76
75 79
78 83
82 87
Range of values per share is from $67 to $83 per share. This is in range of Greenhill's own calculations. WACC also has impact on the above range of values. Changing the WACC from 9% to even 8% or 10%, will change the range to $65 to $87. Fundamentals behind WACC:
Market risk premium
7.10%
Beta (as of July 2008)
0.26
Page 4 of 7
Beta of equity
0.3066
Treasury yield (as of July 2008, 10 years)
4.01%
Cost of capital
6.18%
Commercial debt Long term debt (AAA)
500 2329
2.08% 5.67%
Total debt
2829
5.51%
2829 15761
15.21% 84.80%
Short and long term debt Shareholders' equity
WACC = 0.0551*(1-35%)*0.1521 + 0.848*0.0618 = 5.744%
Since the WACC is different from the initial 9%, we can assume that industry beta has been used. Using the median beta, WACC approximates around 8%. Company Beta
Amgen 0.454
Average Median Adjusted beta
Gilead
Celgene
0.894
0.766
Genzyme 0.658
Biogen 0.767
Cephalon 0.384
0.653833 0.712 0.80992
Using median beta and adjusting it for "the Blume effect", the industry cab be calculated to be 0.80992. Unlevered beta is 0.68. Using these variables, WACC is around 8%. Using 9% WACC is better for Roche as its success depends on pipeline production of Genentech. This way the stand-alone risk will be taken into consideration. To assess the riskiness in a better way, future success of drugs can be treated as real options.
5. What does the analysis of comparable companies (Exhibits 12, 13, and 14) indicate about Genentech’s value within the range established in question 4?
First it is better to examine whether the other firms given are comparable or not. The companies given in exhibit 13 are in the same industry as Genentech, i.e. Biotech industry. Size of Amgen (57396) and Gilead (46073) is close to Genentech’s (88546). But the other companies have capitalization of ¼ or even less. These firms could be highly risky or less liquid, so they should be ignored in the analysis. Growth and risk: Company (Genentech)
Long term growth
Amgen
10.5% (19.2)
Beta 0.454 (0.26)
Page 5 of 7
Gilead Sciences
0.894 (0.26)
24.7% (19.2)
Average
17.60%
0.674
Though Gilead seems to be the closest competitor, yet both the companies will be taken up for analysis. PE multiples Forward EPS
Trailing EPS EBIT
5241
5638
Tax
1834.35
1973.3
Earnings
3406.65
3664.7
Shares
1052
1052
EPS
3.23
3.48
Amgen
12.6
40.802
12.1
42.15
Gilead
25.4
82.25
22.1
76.98
19
61.53
17.1
59.57
Average
Price per share of 76.98 calculated from Gilead’s forward P/E is in the same range as calculated above.
Subtracting cash and securitization and adding back debt will give a value of around 74.818. EBITDA multiples 2009 (forward)
2008 (trailing) EBITDA
5833
6195
Amgen
9.5
9.3
Gilead Average
18.3 13.9
16.2 12.75
12
11.3
Amgen
55413.5
57613.5
Gilead Average
106743.9 81078.7
100359 78986.25
69996
70003.5
Multiple
Industry median Enterprise value
Industry median
Values calculated above are totally different from the values calculated using the DCF analysis. Enterprise Value/Revenue 2008 (trailing)
2009
Page 6 of 7
(forward) Revenue
13418
6195
Amgen
4.1
4
Average
6.7
5.9
Industry median
4.8
4.3
Amgen
55013.8
54140
Gilead
124787.4
105573
Average
89900.6
79856.5
Industry median
64406.4
58200.5
Multiple
Enterprise value
This measure is not a very good measure and is used only when companies do not have any earnings. PEG is also not recommended. Conclusion: Enterprise value is 72676 as per DCF technique, 74818 as per P/E multiple, and a range of 57000-100000 as per EBITDA multiple. These differences prove that using comparable for enterprise valuation is a difficult task especially when the companies differ in size and risk. Nevertheless, these multiples ensure that the stand alone valuation is within the range and thus the offer price of $89 per share is the fair price. These differences also explain differences in consensus by the Wall Street about the price targets. $89 offer price falls within the range which would be suggested for Roche to pay. Iron law of mergers and acquisitions Closing price offer shares left to buy
81.82 89 462.88
value of offered price
41196.32
value at closing price
37872.8416
value of premium value of synergies
3323.4784 4953.205073
syn. Excess of premium
1629.726673
Roche’s shareholders gain as the benefits of synerg ies are more than the premium paid.
6. How has the financial crisis affected Genentech’s value? What changes in valuation assumptions occurred between June 2008 and January 2009?
Page 7 of 7 Lifesaving drugs are necessities which are not affected by the changes in the economic conditions. So the financial crisis also did not affect the revenues and earnings of Genentech. However, the stock price moved with the market; it was the highest in August 2008 at $94 per share immediately after the Roche’s first offe r, and fell from September with lowest in October and November. The crisis did affect the cost of capital and cost of debt. So, the WACC of the company also increased. Also the risky markets led to the increase in the cost of borrowing as the investors moved to safer investment assets.
