Wednesday, February 16, 2011

Sanofi/Genzyme: The Hard Work Begins

It's official. The months of haggling and well-timed media leaks are finally over. But that doesn't mean there aren't a number of unanswered questions tied to Sanofi's $20.1 billion purchase of Genzyme.

In their conference calls with investors and the press, Messrs. Viehbacher and Termeer played chums, outlining the merits of a Sanofi/Genzyme tie-up in the broadest of terms, while still managing to stay mum on specifics. But even with the complete disclosure on the proposed CVR payments, the question ahead of the deal is still the central question today: why is Genzyme, at $74-a- share, a good deal for Sanofi shareholders?

Put another way: does the scarcity factor associated with Genzyme's big biotech status justify its premium price tag, in the same way that oenophiles will pay $5000 to quaff a rare vintage? (Or is this acquisition destined to be tarred with the same problems AstraZeneca has endured in trying to bolt on MedImmune?)

At the deal's current price, Sanofi claims the Genzyme acquisition will be accretive, and possibly by 2012. As their CFO Jerome Contamine put it to investors on the call announcing the deal, "We can tell, as early as today, that this transaction will be accretive to our business earnings, the earning per share, as early as one year after closing; and that it will be accretive by €0.75 to €1 per share by year 2013." Moreover, Contamine also promised the return on capital will be in excess of Sanofi's average cost of capital by year two.

Problem is, it's very hard to confirm such a statement independently without knowing how Sanofi internally defines its cost of capital. (And surprise, surprise, when analysts pushed Sanofi management on the question, they didn't exactly answer, instead noting that "we adjust our cost of capital to each and every investment.") And the company wasn't exactly forthcoming about the synergies it sees post-close either. In the Q&A with investors, Contamine demurred, eventually saying that based on Sanofi's assumptions it anticipates generating "north of $600 million in synergies." But apparently uncertainties, which include an announced performance program for Genzyme employees mean "the accretion more meaningful because it includes everything."

Why does this matter? For starters, because Viehbacher has been vocal in his criticism of blockbuster M&A and the return it provides shareholders. Add in his own admission at the JP Morgan Healthcare Conference that "with cheap debt, you can make almost any transaction look accretive," and it's hard not to be a wee bit skeptical of how such a fully loaded deal is beneficial to Sanofi shareholders.

That's not to say Viehbacher didn't put on a good show -- or that he failed to sell his logic to some portion of Sanofi's shareholders. Sanofi's shares, which are listed on the Paris exchange, closed up 3.5% on February 16, ending the day at €51.55. But that positive reaction could also be relief that the months long back-and-forth has come to an end, and that Viehbacher did what he said he would do, which was close the deal. There's also the possibility that Sanofi investors were simply glad the deal didn't cost them any more than $74 a share upfront; recall that at times over the past few months industry wags have speculated the final deal price could cross the $75-a-share threshold.

But will said investors be so happy if Cerezyme and Fabrazyme sales fail to rebound to their pre- 2009 -2010 levels? The $1 per share contingent value right tied to the continued resolution of manufacturing issues Sanofi won't have to pay will be cold comfort in that scenario; after all, it leaves considerable room for looming competitors to take advantage of what Viehbacher called Genzyme's "gold-standard" brand.

During his call with investors Viehbacher emphasized the diligence Sanofi has done on this front. "We have been out there in the marketplace all along the year, really making sure that the Genzyme brand was not really suffering too much because of production difficulties," he said.

But it's hard not to see the brand as somewhat tarnished either. Some 6000 Gaucher patients are currently being treated for their disease and Genzyme still commands the lion's share of the market, with 4700 getting its enzyme replacement Cerezyme. But the manufacturing snafus have allowed competitors like Shire's Vpriiv to come on strong, with some 1300 patients now being treated by non-Genzyme alternatives. That proportion could grow, especially since patients haven't really had the full option to jump to Vpriiv because of that medicine's supply constraints.

Keep in mind, too, that as early as next week US patients could have yet another therapeutic option--and one that's significantly cheaper than Cerezyme. Pfizer/Protalix's taliglucerase could get a positive nod from regulators on February 25; given the medicine is manufactured using a plant-cell based technology that is more cost-effective than the process Genzyme uses to make Cerezyme, it's widely expected that Pfizer and Protalix will market the medicine at a significant discount, potentially more than the 15% price cut Shire is already offering on Vpriiv.

Even with ongoing improvements in its manufacturing, Genzyme has missed (admittedly only slightly) its pre-released revenue guidance for the Gaucher drug. As Chris Raymond, an analyst with Baird, outlined in a note to investors, fourth quarter Cerezyme sales fell short by $2 million, with the final tally for the drug coming in at just $222 million. Calling the information "surprising", Raymond asked "how does one miss a pre-released number?"

Admittedly a small discrepancy, this failure shows the crack team at Genzyme still has work to do to get its flagship rare disease franchise back on track. And given the deal's price tag, that means Sanofi has a lot of its own work to do as well.

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