Thursday, March 19, 2009

Bio-tech - Is this the Life Science’s Innovation Engine?

Larry and I have been blogging a lot lately about the tsunami of mergers and acquisitions that has been rolling over the pharmaceutical industry recently. We’ve been amazed at how traditional Big Pharma has been collapsing its own excess capacity back on itself.

Let’s talk about two recently announced deals, Merck (NYSE: MRK) and Schering-Plough (NYSE: SGP), (I won’t join the speculation about Johnson & Johnson (NYSE: JNJ) mixing it up with them) and Roche (SWX Europe: ROG) and Genentech (NYSE: DNA). (Regular readers can probably guess what I’m going to say next.) Which one of these deals makes the most sense from an investment perspective?

If you guessed Roche and Genentech then you’re correct! $46.8 billion is a nice piece of change for Genentech. The usual arguments of synergy, efficiency, etc. were given by management.

Roche gets the immediate benefits that come from such deals, improved revenues, earnings, and cashflow. But, what differs from a deal like Merck’s and Schering-Plough’s is that Roche is buying something new. (Alright, alright, I know that Roche already owned 56% of Genentech, but, at least they’re going in the right direction.) Bio-tech is the business differentiator here.

I haven’t had a chance yet to sit down and review the numbers between this deal and Merck’s but supposedly it’s more expensive. Given the future value of Genentech’s drugs, particularly the cancer treatments, that’s to be expected. The question is has Roche overpaid? I believe that’s it’s too soon to tell.

The hard part will now be making this deal work. Different cultures, national as well as corporate, and products are always hard to mesh together. Keeping key employees, particularly Genentech’s in this case, will be crucial. Given the amount of financing involved, Roche will be under significant pressure to produce results. Today’s markets are very unforgiving of missed expectations. Also, should this very expensive acquisition fail, what’s Roche’s chairman, Franz Humer going to do for his next trick? I’m assuming that Genentech’s chairman, Art Levinson, would be long gone by then.

Right now, the Roche and Genentech deal is the one to watch this year. This one’s the outlier. Something has to give in the pharmaceutical industry. The merging of companies with shrinking pipelines in an era of hostile government healthcare policies does not bode well as a good long term strategy for growth. Oh, for sure, there will a survivor. Just as in the auto industry, there will be a shakeout. I’m not ready to guess who that may be. But, I do feel confident that the bio-tech firms will be in a class by themselves. In the future, I’ll blog about why I believe bio-tech will be the engine driving innovation.

As always, we welcome your feedback. Please contact us at We look forward to hearing from you.

Contributed by Guy de Lastin

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