Biotechnology investing: taking a different kind of risk

Investing in medical biotechnology usually entails a large risk: the chance that the promising new therapy the company is developing will not work. Investors in Genentech lose little sleep over that kind of risk, as the company has been remarkably consistent in turning novel molecules into breakthrough drugs.

But Genentech shareholders face a very different sort of risk.Two- thirds of the company is owned by Roche Holdings of Switzerland, which has until June 30 to exercise an option to buy the balance. Should Roche exercise its option by March 31, it can do so at $80 a share; after that, it must pay $82.50.

Genentech shares closed on Friday at $80.75 and have been as high as $84.75 in recent weeks. Since few people buy a stock for $84.75 to sell it for $82.50, much less $80, some investors are clearly betting that Roche will leave Genentech alone. The prospects of two other pioneering biotechnology companies -- Chiron and Immunex -- are also complicated by relationships with pharmaceutical giants: Novartis of Switzerland owns slightly less than half of Chiron, while American Home Products owns 54 percent of Immunex. For Chiron, a so-called standstill agreement with Novartis expires on Dec. 31; after that, Novartis may raise its stake to 55 percent. A similar standstill agreement between Immunex and American Home expired last year and the latter has not increased its position. For now, Genentech is where the action is. Last year, the company received approval for Herceptin, the first biological therapy for metastatic breast cancer; the year before it received approval for a similar drug, Rituxan, for non-Hodgkins lymphoma. These drugs form the basis of a new oncology franchise for Genentech. Together with Activase for heart attack and stroke, Pulmozyme for cystic fibrosis, and the Protropin growth hormone therapy, they helped propel 1998 earnings to $181.9 million, or $1.40 a diluted share, up 41 percent from $129 million, or $1.02 a share, in 1997. Revenues rose 13 percent, to $1.15 billion. What is not clear is whether such success will prompt Roche to buy the remainder of Genentech or to leave well enough alone. Four years ago, when the company was stumbling, Roche passed on a previous option to buy the remaining stake for $60 a share. Under Arthur Levinson, who took over as chief executive in 1995, Genentech has pursued a strategy of increasing profits so that the shares will rise above Roche's option price, perhaps prompting Roche to leave Genentech semi-independent. But some analysts expect the opposite effect. "I think Genentech is the most powerful drug development engine in all of pharmaceuticals, including big pharma," said Richard A. van den Broek, an analyst with Hambrecht & Quist. He expects Roche to exercise its option. "They are in the drug development business, not the fund management business," he said. There is little doubt that Levinson would like to continue as head of a semi-independent Genentech. Previously Genentech's chief scientist, he has flourished as the company's chief executive. "If we didn't have the Roche deal, I wouldn't be losing a minute of sleep on whether we could survive as an independent company," he said in an interview. "We expect to increase earnings 20 percent a year for the next several years." The company's future growth will come from a broad and deep pipeline of new drugs. Genentech is filing for approval of a sustained-delivery version of its human growth hormone and has six drugs in the final phase of clinical trials alone. "Investors are betting that if Roche does step out of the way, the stock is going to $100," said Robert Toth, an analyst with Vector Securities.

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