Page 1 of 7

Case Study
1. Why is Roche seeking to acquire the 44% of Genentech it does not own? From Roches 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 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 Genentechs shares:

The merger will lead to formation of the worlds 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 allowing it to distribute Genentechs best selling
drugs.

Risks of owning 100% of Genentechs shares:

The acquired companys minority shareholders are mostly its employees. The companys
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 Roches 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.
Genentechs 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.
 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
Roches 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%

2013 and
2009 2010 2011 2012 thereafter
FCF $138.05 $362.36 $436.47 $475.58 $488.81
Terminal Value $5,431.22
Discounted $3,529.92 Shares 1052
NPV $1,423.28 Shares to buy 463
Value per
Total value $4,953.21 share $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% 69 72 75 78 82
8% 73 76 79 83 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 500 2.08%

Long term debt (AAA) 2329 5.67%
Total debt 2829 5.51%
Short and long term debt 2829 15.21%
Shareholders' equity 15761 84.80%

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 Amgen Gilead Celgene Genzyme Biogen Cephalon

Beta 0.454 0.894 0.766 0.658 0.767 0.384
Average 0.653833
Median 0.712
Adjusted beta 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
Genentechs 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 Genentechs (88546). But the other companies have capitalization of or even
less. These firms could be highly risky or less liquid, so they should be ignored in the analysis.

Growth and risk:

Company Long term
(Genentech) growth Beta
0.454
Amgen 10.5% (19.2) (0.26)
 Page 5 of 7

0.894
Gilead Sciences 24.7% (19.2) (0.26)
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
Trailing EPS 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
Average 19 61.53 17.1 59.57

Price per share of 76.98 calculated from Gileads 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
2008 (trailing) (forward)
EBITDA 5833 6195
Multiple
Amgen 9.5 9.3
Gilead 18.3 16.2
Average 13.9 12.75
Industry median 12 11.3
Enterprise value
Amgen 55413.5 57613.5
Gilead 106743.9 100359
Average 81078.7 78986.25
Industry median 69996 70003.5

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
Multiple
Amgen 4.1 4
Average 6.7 5.9
Industry median 4.8 4.3
Enterprise value
Amgen 55013.8 54140
Gilead 124787.4 105573
Average 89900.6 79856.5
Industry median 64406.4 58200.5

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 81.82
offer 89
shares left to buy 462.88
value of offered price 41196.32
value at closing price 37872.8416
value of premium 3323.4784
value of synergies 4953.205073
syn. Excess of premium 1629.726673

Roches shareholders gain as the benefits of synergies are more than the premium paid.

6. How has the financial crisis affected Genentechs 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 Roches first offer, 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.