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Derek Lowe The 2002 Model

Dbl%20new%20portrait%20B%26W.png After 10 years of blogging. . .

Derek Lowe, an Arkansan by birth, got his BA from Hendrix College and his PhD in organic chemistry from Duke before spending time in Germany on a Humboldt Fellowship on his post-doc. He's worked for several major pharmaceutical companies since 1989 on drug discovery projects against schizophrenia, Alzheimer's, diabetes, osteoporosis and other diseases. To contact Derek email him directly: Twitter: Dereklowe

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March 12, 2009

Roche / Genentech: The Chase Is Over

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Posted by Derek

So Roche and Genentech have come to terms: $95 per share. They'd offered more last fall, but, well, it isn't last fall any more. And this was still well above Roche's recent offers, although they'd come up to $93 in public before this was announced this morning. Genentech shares had been climbing up to much closer to Roche's revised offer, so the deal was starting to become clearer in the last couple of days.

What's this going to mean? The main encouraging thing I can take out of it is that Roche is saying that they want to keep Genentech's R&D operation separate, and to keep their talent and their approach to discovery. It's nice to at least hear lip service to that idea - it's a start - but now we'll have to see if they follow through.

Overall, though, I don't like big mergers, as has been a repeating theme around here. And now we've had three whoppers in just the last few months: Pfizer/Wyeth, Merck/Schering-Plough (I know, I know, I'm supposed to have those names the other way around, but come on), and now Roche/Genentech. So I can't say that the industry is moving in a way that makes me really happy. But at the same time, I can see why all this is happening, so perhaps it's the underlying trends which lead to these things that should be making me unhappy - I should be upset about the causes, not the symptoms. (Mind you, I think that the decreased research productivity that accompanies some of these mergers tends to blend the whole cause and effect relationship up a bit).

And it's important not to confuse these moves with the current financial mess. The drug industry has problems totally outside the turmoil in the credit and equity markets. If anything, some of these conditions are making it harder to do the deals that the companies themselves feel like they have to do (look, for example, at how Pfizer had to work to get the financing together for the Wyeth takeover). No, if the markets were in better shape, we'd be seeing the same sort of thing - maybe a bit faster, or a bit slower, but different only in degree, not in kind.

We aren't producing enough good new drugs quickly enough. Collateralized debt obligations and credit default swaps have nothing to do with that. And we're either going to have to find ways to increase our research productivity, or batten down the industry for survival under the conditions we have now. Mergers, right- or wrong-headed, are part of the latter process. If we could find a way to do the former one, we wouldn't be in the shape we're in now.

Comments (16) + TrackBacks (0) | Category: Business and Markets | Drug Industry History


1. Kay on March 12, 2009 7:53 AM writes...

California will be gaining some of the most productive and smart folks in the industry. Will Roche contract with movers to run a regular route from NJ to CA? This would be cheaper than ad hoc shipments.

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2. anon on March 12, 2009 8:17 AM writes...

DNA has been "dead man walking" for some time: lots of job ads; no hiring. It is sad to see another great company bite the dust. Roche only wants the protein therapeutics, regardless on whatever they might be saying in the press.

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3. anon on March 12, 2009 10:39 AM writes...

Derek, a correction, the original offer last year was $89, so this is above that value. The stock traded above $95 for a while, as people assumed it was going to be closer to $100 until the market collapsed.

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4. anon2 on March 12, 2009 10:41 AM writes...

Of course Roche only wants the protein therapeutics - there is nothing else. Genentech's small molecule efforts are still in a fledgling state, and I would be surprised to see that remain untouched over the coming months. My bet is that Nutley becomes the main US site for small molecules - South San Francisco will lose (cut) that part of their efforts. Hopefully those folks will be offered positions in Nutley, but it will result in net cuts - anything else doesn't make any sense.

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5. barry on March 12, 2009 1:29 PM writes...

It's clear that Roche wants Genentech's Intellectual Property. It's not clear that they're committed to Genentech's R&D. Roche has a lot of Development capacity already that is under-employed. Is there a place for Genentech's (very successful but much smaller) Development group in the larger organization? Is there a place for Genentech's nascent small-molecule research efforts on the larger organization? Somewhere a pencil-pusher is tabulating the savings that would come from slashing these "redundancies".

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6. CMC Guy on March 12, 2009 2:09 PM writes...

I concur that lack of "good new drugs quickly enough" is a root cause issue for present state of (sad) affairs. I view this as a bit of a Catch-22 since past Mergers exacerbated spread of "blockbusteritis" where only certain markets/targets were of interest post-integration. A counter argument could be made that some projects did get spun-off or outlicensed although relatively few that I know of actually succeeded. Likewise can suggest the "availability of experienced" personnel aided small pharma/biotech efforts however level of that impact unclear. Because of complexity,the long timeframes, and general failure rate of drug R&D its tough to speculate what would have happened or what might occur to a individual company or Pharma in general with or without a merger. The termination of people & projects, and the stress of the situations would seem immediate negatives but perhaps in cases a refocus and reorganization will better position a company in the long run.

In terms of "dollars" these three mergers involve total of $156B. Recent PHRMA report indicated $65B for R&D in 2008 (combined pharma and biotech). Which do you think was the better investment? Alternatively would that merger money being into R&D have greater long term impact? I know this is apples and bananas but does involve priorities.

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7. fred on March 12, 2009 3:19 PM writes...

"In terms of "dollars" these three mergers involve total of $156B. Recent PHRMA report indicated $65B for R&D in 2008"

You hit the nail on the head. So many drug targets and under-treated diseases in the world and all these former fast-food executives give us is fewer scientists to address these problems! The world has much greater intrinsic need to chemist than MBA's, IMHO!

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8. srp on March 12, 2009 10:47 PM writes...

I wonder whether the blockbusteritis syndrome is the result of bad cost accounting where fixed costs are inappropriately allocated to projects instead of using a proper contribution analysis?

Given the billions of dollars potentially lost from such an elementary error, it's hard to believe, but a lot of technically trained people who get MBAs aren't that good at economic analysis...And the publishing industry allegedly made this mistake for decades without any help from MBAs at all.

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9. BigSky on March 13, 2009 1:25 PM writes...

Let's break this down my way for a minute...
156 B$ and not a single new drug entity> check
Smaller R+D with reduced scope> check
Fewer buyers for whatever new entities biotech comes up with> check
Leading to smaller bids for those entities> check
Leading to reduced incentives for capitol to flow to biotechs> check

Fewer Pharma > fewer R+D resources > smaller R+D focus > greater reliance on acquiring outside compounds > fewer competitive dollars for those outside compounds > less startup and VC capitol incentive > fewer biotechs > where is this cycle going?

Or am I just bent?

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10. CMC Guy on March 13, 2009 2:26 PM writes...

srp I am not real clear on what you are asking/saying but most of the R&D project costs models I have seen (lived) have appeared to be poor reflections of reality. I can only speak from my own experiences where typically seen applied are standard costs (loosely based on historical data) associated with particular functions/activities/stages/time cycles (fixed and variable) which get listed out and then do the math. Invariably the R&D plans go through multiple changes with the costs models rarely revisited. Normally by the time (if) hits commercial enough is clear to generate more meaningful costs and reliable predictions. However in terms of blockbusteristis there is the Market size/Sales projections(drug capture%) as the big driver upfront. First projects get screened against those estimates (which have even greater degree of skepticism) for "fit". Then the project costs calculations come into play with gating factors on the delta between them determining levels of interest. I would say most the people generating this data are not technical-turned-MBA but do come from business backgrounds (and just as in science there seems to be different opinions of the hows).

BigSky I can make some of the same connections but I am probably bent.

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11. Hap on March 13, 2009 3:13 PM writes...

1) But wait! There's some good news after all, because the merging companies are getting rid of lots of chemists, biologists, and drug development people, so you can get lots of experienced people for cheap. So even though you can't make much money, you can hire people for cheap and not even leave the country (and by the time potential employees realize this and leave the field in flocks the stock options of the people who financed this will have vested and they will be long gone, probably somewhere without an extradition treaty). Except for CEOs, of course, because their invaluable leadership becomes incredibly important in times like this...

I guess the quality of good news really is getting worse.

2) If merging doesn't improve your research pipelines and saps your cash (when said cash is hard to come by), what is the point? Just because you think you have to do something does not mean either that you should do something, or that merging is what you should do. If anything, it seems to make companies worse off in the near and middle terms (if competition with the gov't and regulation is the goal, it might sort of work in the long term, if you can actually find drugs).

Merging seems like a solution for stock analysts and investment banks desperate for business, for upper management with stock options and nice parachutes, and maybe for stockholders looking to cash out. It doesn't really seem like a good solution to finding better drugs, or for surviving an economic downturn, or for solving the industry's systemic problems. It seems closer to surrender, with the added bonus of exacerbating the problems for everyone else. I guess that's one solution for the ability to find useful drugs.

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12. anon on March 13, 2009 7:48 PM writes...

I've always sorta felt like pharma would be better off--for the most part--if privately held rather than publicly traded. Drug discovery is a process with a time horizon of many years, and it's difficult to do that effectively when you're trying to please your shareholders once a quarter and stock analysts are making hay about your EPS guidance. Is Boehringer-Ingelheim going belly-up, merging, laying off thousands of staff? No. Nor are they immune to the productivity problems that plague the industry right now, but that's the point. B-I is privately held, and the family owners are seemingly content with their return on investment. A small group of owners who are willing and able to take the long view would be a lot better for drug discovery than trying to assure quarterly dividends are handed out and the stock price is always on the rise.

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13. MTK on March 14, 2009 11:00 AM writes...

Big Sky,

Yes, you are bent. Actually, just a little over the top.

And CMC, here's some non-stock data for you.

Here's some data that I looked up.

I looked at the Top Pharma as of 2006 as listed in Wikipedia. I threw out JNJ and Bayer since they are not pure pharma plays, grouped the top five that are mega-merger companies (PFE, GSK, Novartis, Sanofi, and AZ) and the top five non or limited merger companies (MRK, ABT, BMY, LLY, and Schering). Note, that beyond merger and non-merger it's also very much a European vs. US grouping. OK, I know Abbott is also very diversified, but not as much as JNJ or Bayer. The one company I left out was Wyeth, because the definition gets hazy. They were formed 15 years ago through the Cyanamid merger and that straddles the line.

Here are some numbers comparing the groups with the merger group first:

2006 revenues: $190B, $89B
2006 R&D expenditures: $28.7B, $15.4B
R&D spending as % revenue: 15.1%, 17.3%
# of NME's approved from 05-present: 14, 8
R&D $ spent/ approved NME: $2.05B, $1.93B
Revenue/employee: $355K, $301K
Workforce reductions since 2006: -14%, -12%.

As you look at those numbers, you can make an argument that the mergers haven't worked and you'd be right in the sense that they haven't provided a competitive advantage. But considering that most times companies that merge aren't exactly on an upward track (hence the merger), it has allowed them to keep pace. Look at Wyeth and Pfizer. Wyeth's two biggest sellers are coming off patent in 2011 as is Lipitor.

And while the organic growth companies have spent more on R&D as a %, they have not really been any better in finding new NME's per dollar spent. If the merger group would have increased R&D spending up to 17.3%, it would result in only one more NME over 3 years for the entire group of five. Regardless, given the small number of NME's in both groups over the last four years, it's safe to say we all stink, merger or no.

As for licensing, the top four companies, GSK, Novartis, Pfizer, and Roche, are all products of mergers and have accounted for almost 50% of all deals in the last several years. Of course, everything for 2009 has changed, but since 2000 the # and size of deals has steadily increased, despite (or maybe because) of the M&A activity.

In terms of jobs, everyone has been downsizing. There are job losses whenever a merger occurs, on average about 10,000 per merger, but once again it's hard to say what would have occurred without the merger. Case in point, the two biggest announced layoffs for 2008 were Merck and Schering with 8500 and 5500 apiece. Now they didn't let those people go immediately, so I'm not sure how many of those are included in the 16,000 post-merger jobs that are being lost.

Finally, the $165B is not all cash and it's certainly not all cash lying around. That is the value of the deals. The cash portion is going to have to be borrowed, so just saying it could have been spent on R&D is not true. That's like having a 200K mortgage and thinking if I had moved into a 100K place instead I'd have an extra 100K to spend. No. The bank gave you 200K for a specific purpose with set terms including how and when you have to pay it back.

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14. MTK on March 14, 2009 11:47 AM writes...


The $ spent/NME takes 2006 R&D spending and divides it by NME's produced between 2005-2009. My assumption is that R&D spending levels have not changed dramatically for either group over that five year timespan.

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15. Hap on March 14, 2009 4:48 PM writes...

If there's significant cash involved with a merger, doesn't that mean that the cash spent on the merger can't be used for anything else (any other way of increasing productivity or, if you thought you were OK, the ability to survive a drought)? That might be a problem.

If the above numbers are correct, whatever the short-term effects, mergers don't do much either way to increase or decrease productivity. Of course, that would imply that there's something else driving them - spending large amounts of cash in a relatively bad credit market (where credit might not be easily available or cheap) to buy another company and then lay off a chunk of workers (probably paying severance, etc.) to do something that doesn't help you (even if it doesn't hurt) doesn't seem smart.

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16. Anonymous on March 15, 2009 8:03 PM writes...

No other choice! Merck would not survive if it had not done the merger. And it is not the same Merck anyway since this Dick took over. All he has done is to please Wall Street with waves after waves of cutting and dreaming that he could make to the cover of Time magazine just as George Merck did. But it is not going to work because the Morale is so low, the scientists cannot innovate any more. He also lauched a "cultural revolution" that is eliminating many of the top scientists in the name of "leadership'. Merck is going to fail if he is not replaced.

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