Case04

Posted on February 3, 2017

Roche Case Study Analysis Help With Solutions

Roche
In 1894, Swiss banker Fritz Hoffmann-La Roche, 26, joined Max Carl Traub to take over a small factory on Basel’s Grenzacherstrasse from druggists Bohny, Hollinger & Co. Following a difficult first two years, Hoffmann-La Roche bought out his partner and entered F. Hoffmann-La Roche & Co. in the commercial register.

Market
The past 18 months had been historic for global financial markets, with dramatic declines in equity and credit markets. Since October 2007, world equity market prices had declined over 45%. Large numbers of commercial and investment banks had failed. The global labor market was shedding jobs, resulting in sharp increases in unemployment rates. Broad economic activity was also affected, with large declines in overall economic activity.

The Bond Offering process 
The issuance of publicly traded bonds, in addition to the pricing and marketing of the deal, required the satisfaction of certain legal requirements. Because of the complexity and importance of these two processes, corporations typically hired investment bankers to provide assistance. Given the size of the deal, Roche hired three banks as joint lead managers for the U.S. dollar deal (Banc of America Securities, Citigroup Global Markets, and JPMorgan) and four bankers for the euro and pound sterling deals (Barclays Capital, BNP Paribas, Deutsche Bank, and Banco Santander).
Because Roche’s bonds would be publicly traded, it had to file with the appropriate regulatory agencies in the countries where the bonds would be issued. Simultaneous with the drafting of the documentation by legal teams, the underwriting banks’ debt capital markets and syndication desks began the marketing process. The initial phase of this process was the “road show.” During the road show, management teams for Roche and the banks held initial meetings with investors from all over the world. The Roche management team expected to meet with investors in many of the major investment centers in the United States and Europe.
Given the global nature of Roche’s business, the banks determined that a mix of bonds at different maturities and in different currencies was the best option. By matching differing maturities and currencies to the company’s operating cash flows in those currencies, Roche was able to reduce exchange rate risk. Exhibit 10 provides an overview of the different currency and maturity tranches planned in the offering. The final amounts raised from each offering, along with the coupon rate, were not yet determined because pricing was expected to be highly influenced by investor demand. To ensure that the bond offering raised the targeted proceeds, the coupon rate was set to approximate the anticipated yield, such that the bond traded at par. Following market conventions, the U.S. dollar bonds would pay interest semiannually, and the euro and sterling issues would pay interest annually.
The coupon payments of the shorter durations were to be floating, and the interest to be paid was equivalent to the short-term interbank interest rate (LIBOR) plus a credit spread. The longer durations were to have fixed coupon payments for the duration of the bond. Investors typically referenced the “price” of bonds as the spread over the applicable risk-free rate. The risk-free rate was commonly established as the respective government borrowing rate and was referred to as the benchmark, sovereign, or Treasury rate. The logic of the credit spread was that bonds were riskier than the benchmark bonds, so to entice investors, the issuer had to offer a price over the risk-free rate.
During the road show, banks received feedback from investors on the demand for each tranche. Determining the final size and pricing of each issue was an iterative process between the investors, banks, and issuer. In the case of Roche, if investors showed strong demand for the four-year euro tranche, Roche could decide to either issue more at that price (thus reducing the amount of another tranche) or lower the coupon and pay a lower interest rate on the four-year euro issue. The banks’ process of determining demand and receiving orders for each issue was known as book-building. Bond prices were set based on prevailing yields of bond issues by similar companies. Exhibit 11 and 12 provide a sample of prevailing prices and terms of company bonds traded in the market, in addition to various equity market and accounting data.

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The Genentech Deal
On July 21, 2008, Roche publicly announced an offer to acquire the 44.1% of Genentech’s outstanding shares that it did not already own. The offer price of USD89.00 represented a 19% premium over the previous one-month share prices for Genentech. Roche management believed that economies justified the premium with an estimate that, following the transaction, the combined entity could realize USD750 million

to USD850 million in operational efficiencies. Following the offer, Genentech’s stock price shot up beyond the USD89.00 offer price with the anticipation that Roche would increase its offer.
On August 13, 2008, a special committee of Genentech’s board of directors (those without direct ties to Roche) responded to Roche’s offer. The committee stated that the offer “substantially undervalues the company.” Without the support of Genentech’s board of directors, Roche needed either to negotiate with the board or take the offer directly to shareholders with what was known as a tender offer. In that case, shareholders would receive a take-it-or-leave-it offer. If sufficient shareholders “tendered” their shares, the deal would go through regardless of the support of the board.
Over the next six months, capital markets fell into disarray. As credit markets deteriorated, Genentech shareholders realized that Roche might not be able to finance an increased bid for the company, and the share price continued to decline through the end of the year. Contemporaneously with the deal, Genentech awaited the announcement of the clinical trial results for several of its next generation of potential drugs, including its promising cancer drug Avastin.
On January 30, 2009, Roche announced its intention to launch a tender offer for the remaining shares at a reduced price of USD86.50. The revised offer was contingent on Roche’s ability to obtain sufficient financing to purchase the shares. The announcement was accompanied by a 4% price drop of Genentech’s share price to USD80.82. Bill Tanner, analyst at Leerink Swann, warned Genentech shareholders that the stock was overvalued and that if upcoming Genentech drug trials showed mediocre results then the stock would fall into the USD60 range. He encouraged shareholders to take the sure USD86.50 offer claiming that “DNA’s [the stock ticker symbol for Genentech] best days may be over.”2
Jason Napadano, analyst at Zach’s Investment Research, claimed that Roche was trying “to pull the wool over the eyes of Genentech shareholders.” He continued, “Roche is trying to get this deal done before the adjuvant colon cancer data comes out and Genentech shareholders are well aware of that. I don’t know why they would tender their shares for [USD]86.50, which is only 10% above today’s price, when they can get closer to $95 to $100 a share if they wait.”

Unlike Pfizer in its acquisition of Wyeth, Roche could not issue equity to Genentech shareholders. Roche was controlled by the remnants of its founder in the Oeri, Hoffman, and Sacher families. The company maintained two classes of shares, bearer and Genussscheine (profit-participation) shares. Both share classes had equal economic rights (i.e., same dividends, etc.) and traded on the Swiss Stock Exchange, but the bearer shares were the only shares with voting rights, and the founding family controlled just over 50% of the bearer shares. This dual-share structure existed before modern shareholder rights legislation in Switzerland and was grandfathered in. In the event Roche were to issue equity to Genentech shareholders, this dual-class share structure would have to be revisited, and the family might lose control. Given this ownership structure, Roche was forced to finance the deal entirely of debt and current cash on hand.
When Roche originally announced the transaction, the company had intended to finance the acquisition with a combination of bonds and loans from a variety of commercial banks. The collapse of the financial

The Financing Proposal
Unlike Pfizer in its acquisition of Wyeth, Roche could not issue equity to Genentech shareholders. Roche was controlled by the remnants of its founder in the Oeri, Hoffman, and Sacher families. The company maintained two classes of shares, bearer and Genussscheine (profit-participation) shares. Both share classes had equal economic rights (i.e., same dividends, etc.) and traded on the Swiss Stock Exchange, but the bearer shares were the only shares with voting rights, and the founding family controlled just over 50% of the bearer shares. This dual-share structure existed before modern shareholder rights legislation in Switzerland and was grandfathered in. In the event Roche were to issue equity to Genentech shareholders, this dual-class share structure would have to be revisited, and the family might lose control. Given this ownership structure, Roche was forced to finance the deal entirely of debt and current cash on hand.
When Roche originally announced the transaction, the company had intended to finance the acquisition with a combination of bonds and loans from a variety of commercial banks. The collapse of the financial

markets caused many of the commercial banks to demand a much higher interest rate on the loans than originally anticipated by Roche. As a result of the change in market conditions, Roche was limited to the bond market for the majority of its financing. Despite the magnitude of the debt-financing need, the investment banks assisting in the deal expected that Roche’s cash flow was stable enough to manage the additional level of debt.
To ensure that Roche raised the necessary capital, it was important to correctly anticipate the required yield on each bond and set the coupon rate at the rate that would price the bond at par. This was done by simply setting the coupon rate equal to the anticipated yield. With such a substantial amount of money riding on the deal, it was critical that Roche correctly set the price, despite the immense uncertainty in capital markets.

Roche Holding AG: Funding the Genentech Acquisition Case Questions

Q1. What are the business and financing risks associated with the acquisition of Genentech? Is this a good time to do the deal?

Q2. Do you believe the bond issuance will have an impact on Roche’s bond rating?

Q3. What are the prevailing spreads for non-Roche bonds? Do you think these spreads are similar to investor’s required yield for the Roche bonds?

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