Roche Prep Sheet:
What coupon rate should Roche offer for its bonds so that they can be sold at par?
1.Do you agree with the timing of the bond offering? Is it a ‘good time’ to issue?
2.Do you anticipate that the offering will affect Roche’s bond rating? If so, in what way?
3.How can weestimatethe yield investors will require on a bond? What are yourestimatesof investors’ required yields for the 5-year, 10-year, and 30-year US dollar bonds?
a.First estimate the yields for the Roche bonds using the information in Exhibit 6
b.Nest estimate yields based on information in Exhibit 11 (you can assume all bonds have a par value of $100)
c.Which estimate do you trust more? Why? How would you explain to someone unfamiliar with credit markets why these estimation techniques are valid?
4.What is your estimate of investors’ required yields for the 7-year Euro denominated bond? Can you just use the same techniques as you did in Question 3?
Roche Holding AG: Funding the Genentech Acquisition UV5641 Rev. Nov. 8, 2018 Roche Holding AG: Funding the Genentech Acquisition We are confident that we will have the financing available when the money is needed…The plan is to use as financing partly our own funds and then obviously bonds and then commercial paper and traditional bank financing. We will start by going to the bond market first.1 —Roche Chairman Franz Hume In July 2008, Swiss pharmaceutical company Roche Holding AG (Roche) made an offer to acquire all remaining outstanding shares of US biotechnology leader Genentech for (US dollars) USD89.00 per share in cash. Six months later, with equity markets down 35%, Roche announced its recommitment to the deal with a discounted offer of USD86.50 in cash per share of Genentech stock. To pay for the deal, Roche needed a massive USD42 billion in cash. To meet the need, management planned to sell USD32 billion in bonds at various maturities from 1 year to 30 years and in three different currencies (US dollar, euro, and British pound). The sale would begin with the dollar-denominated offering and follow up soon after with rounds of offerings in the other currencies. In mid-February 2009, Roche was ready to move forward with what was anticipated to be the largest bond offering in history. With considerable ongoing turmoil in world financial markets and substantial uncertainty surrounding the willingness of Genentech minority shareholders to sell their shares for the reduced offer of USD86.50, Roche’s financing strategy was certainly bold. Roche In 1894, Swiss banker Fritz Hoffmann-La Roche, 26, joined Max Carl Traub in taking 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. In the early years, the company’s primary products included sleeping agents, antiseptics, and vitamins; by the late 1930s, the company had already expanded to 35 countries, an expansion that continued in the decades following the Second World War. In 1990, the company, by then known as Roche, acquired a majority stake in 1 Sam Cage, “Roche Goes Hostile, Cuts Genentech Bid to $42 Billion,” Reuters, January 30, 2009. This case, based on publicly available data, was prepared by Brett Durick (MBA ’11), Drew Chambers (MBA ’11), and Michael J. Schill, Robert F. Vandell Research Associate Professor of Business Administration. This case is dedicated to Courtney Turner Chambers, in recognition of the sacrifice and contribution of all Darden partners. It was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright 2011 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an email to
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[email protected] https://USD86.50 https://USD86.50 https://USD89.00 Tiffany Tuttle Tiffany Tuttle Tiffany Tuttle Tiffany Tuttle Tiffany Tuttle Tiffany Tuttle Tiffany Tuttle Page 2 UV5641 Genentech, a south San Francisco biotechnology company, for USD2.1 billion. Genentech’s research focused primarily on developing products based on gene splicing, or recombinant DNA, to treat diseases such as cancer and AIDS. The acquisition gave Roche a strong foothold in the emerging biologics market as well as stronger presence in the US market. Since the 1990s, Roche had maintained focus on its two primary business units, pharmaceuticals and medical diagnostics; in 2004, Roche sold its over-the-counter consumer health business to Bayer AG for nearly USD3 billion. In 2008, Roche expanded its diagnostics business with the acquisition of Ventana Medical Systems for USD3.4 billion. By the end of 2008, Roche’s total revenue was just shy of (Swiss francs) CHF50 billion. The pharmaceutical division contributed 70% of the total Roche revenue and over 90% of the operating profit. Roche was clearly one of the leading pharmaceuticals in the world. Exhibit 1 provides a revenue breakdown of Roche’s 2008 revenue by geography and therapeutic area, as well as a detailed overview of Roche’s top-selling pharmaceutical products. Roche and Genentech’s financial statements are detailed in Exhibits 2 and 3, respectively, and the stock performance of the two companies is shown in Exhibit 4. Market Conditions 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. In response to what some feared would become the next Great Depression, world governments made massive investments in financial and industrial institutions. In an effort to stimulate liquidity, central banks had lowered interest rates. The market uncertainty was accompanied by a massive “flight to quality” as global investors moved capital to government securities (particularly US Treasuries), thereby driving government yields to historic lows. Exhibit 5 shows the prevailing yield curve in US dollars, euros, and British pounds. With benchmark yields declining but overall borrowing rates rising, the credit spreads (the differences between corporate yields and benchmark yields) were expanding to historic levels. Exhibit 6 contains the prevailing credit spreads over benchmark yields for US industrial corporate bonds based on bond ratings from bond- rating agency Standard and Poor’s. Exhibit 7 plots historical trends in yields of bonds by various credit ratings over the past two years. Exhibit 8 provides a definitional overview of Standard and Poor’s credit ratings. Roche’s current credit rating with Standard and Poor’s was AA−, and with Moody’s was Aa1. Exhibit 9 details median values for various financial ratios for companies rated within a particular category for 2007 and 2008. Despite the uncertainty in the credit markets, corporate transactions were reawakening in the pharmaceutical industry. Pfizer had recently agreed to acquire Wyeth for USD68 billion. In the deal, five banks had agreed to lend Pfizer USD22.5 billion to pay for the deal, and Pfizer was funding the remaining USD45.5 billion through issuance of a combination of cash and stock. 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 US dollar deal (Banc of America Securities, Citigroup Global Markets, For the exclusive use of G. UNIVERSITY, 2022. This document is authorized for use only by GEORGETOWN UNIVERSITY in 2022. Tiffany Tuttle Tiffany Tuttle Tiffany Tuttle Tiffany Tuttle Tiffany Tuttle Tiffany Tuttle Tiffany Tuttle Tiffany Tuttle Tiffany Tuttle Tiffany Tuttle Tiffany Tuttle Tiffany Tuttle Tiffany Tuttle Tiffany Tuttle Tiffany Tuttle Tiffany Tuttle Page 3 UV5641 and JPMorgan) and four banks 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 US 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