ZURICH Swiss drugmaker Roche ROG.VX, long considered a bullet-proof investment, could be coming back down to earth due to a combination of slowing growth and worries over its multibillion dollar bid to buy out Genentech DNA.N.
This has brought Roche Holding's previous premium stock market rating down towards parity with some peers and upped pressure to conclude the Genentech deal successfully, underlined by the start of its tender offer this week.
Yet Roche's promising drug portfolio means it could still be a good long-term investment, particularly if it can force through a Genentech deal at a good price.
"Premium portfolio equals premium growth -- but when?" said WestLB analyst Andreas Theisen. "We fear that the potential for relative expansion of multiples could be limited near term due to modest earnings growth in 2009."
For a long time, Roche was significantly more expensive than competitors like GlaxoSmithKline Plc (GSK.L), Europe's largest drugmaker, thanks to its strong portfolio of high-margin cancer medicines and other promising new drugs.
In mid-2007, Roche was trading at a premium of some 25 percent to the average of Europe's big pharmaceutical companies.
That has gradually been eroded over the past few months as slowing growth and uncertainties over a $42 billion (28.4 billion pounds) bid to buy the 44 percent of U.S. biotech group Genentech it does not already own weigh.
Healthcare is traditionally one of the last areas where consumers cut spending in a downturn, but Roche's stock has fallen 9 percent this year, compared with a near flat performance by the European healthcare sector .SXDP.
Roche now trades at almost 11 times forecast 2010 earnings, only just ahead of a multiple of 10 for both Glaxo and local Swiss rival Novartis NOVN.VX, 8 for Europe's No. 2 drugmaker Sanofi-Aventis (SASY.PA) and 7 for AstraZeneca (AZN.L).
"We think that the market's short-term focus has led to a significant erosion of Roche's premium to the sector in recent years," said JP Morgan analyst Alexandra Hauber.
Roche's attempt to buy out Genentech has overshadowed the performance of its own business, but most analysts believe the takeover would be a good move as it would add good assets, provide room for cost cutting and be quickly earnings accretive.
However, there is still concern over whether Roche can raise the required financing and most observers believe it will have to up the current bid of $86.50 per Genentech share. UBS analysts have calculated a deal would be value accretive for Roche at up to $124, while Genentech closed at $82.70 on Monday.
Roche's disclosure of the U.S. group's internal financial projections in its tender document could also unsettle some Genentech shareholders, Morgan Stanley's Andrew Baum believes.
Some even wonder whether Roche's decision to go hostile -- announced just days before the release of its 2008 results -- could actually have been prompted by the prospect of slowing growth, as well as the strengthening U.S. dollar and tighter credit conditions.
Another key event will be the results of a trial of Genentech's blockbuster Avastin, which Roche markets outside the United States, in colon cancer patients who have undergone surgery, due in April.
Positive results from that trial could prompt a rally in Roche, but also in Genentech, likely increasing the price the Swiss company might end up paying.
"The proposed offer is a sign that credit markets have improved enough that Roche is confident to find financing at reasonable conditions," said David Kaegi at Swiss wealth manager Sarasin. "The outcome, in our view, is open but the pressure on Genentech's board increases."
Roche's business is underpinned by big-selling drugs which are still growing, and the company has limited exposure to copy-cat generic medicines -- factors which could make Roche a good bet for investors taking a longer view.
Analysts say Roche's lacklustre short-term growth outlook should not be too much of a concern, since it was prompted mainly by lower expectations for financial income, when interest rates are very low, and increased research spend which is likely, eventually, to yield benefits.
In addition, it has existing blockbusters, such as its three key cancer drugs -- Avastin, Herception and MabThera, which each netted more than 5 billion Swiss francs (2.9 billion pounds) in sales in 2008 and are still growing -- and promising new drugs still in the pipeline, such as Actemra for rheumatoid arthritis.
Roche's focus on research and development spending, although it hurts the short-term earnings outlook, could net significant rewards in a few years' time.
The group's net profit is expected to rise at rates of 10 percent and more over the next three years, according to Thomson Reuters data.
"There is no doubt that, with its overwhelming position in oncology, Roche has above average growth potential considering its very modest exposure to patent expiry," WestLB's Theisen said.
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(Editing by Simon Jessop)