How Will Genentech Respond to Roche's European Trading Loss?

Shares of Roche Holdings surrendered a tidy sum of 14 Swiss Francs per share in European trading this morning, equivalent to a loss of more than 8.5% of its value. Normally, such a move in shares of Switzerland's largest drug maker would likely be met with little notice in the United States, but Roche's (RHHBY.PK) outstanding hostile bid for US biotech company Genentech (DNA) has the market on its toes.

The drama started on July 21st of last year, when Roche, already holders of more than 56% of Genentech's stock, offered $89 per share in cash for the remainder of the US firm. After trading up on the offer, the biotech's directors declined the offer, an 8.8% premium on the company's then-present value.

In the interim, shareholders of Genentech have had largely good news to digest. Last month, the company reported a 47% surge in fourth quarter profit, driven by strong sales of cancer drugs. Sales of Avastin, the company's most successful product, increased by 21%. While both announcements missed analysts' estimates by slim margins, the company's fundamentals appear strong, and strengthening. And, the firm's forecast of 2009 earnings of $3.55 to $3.90 a share seem increasingly attractive in the current market.

Details of talks between the two drug giants' boards had remained largely out of the media. Then came Friday, when Roche announced a 2.8% cut in its offering price for Genentech. When asked for the rationale behind the cut, Roche executives pointed to fresh weakness in the Euro, the biotech sector, and the global economy in general. Some observers pointed out that since July, the cost of the deal in Euros had risen from € 56 to over €59.5 , an increase for Roche of over 6%. Shares of Genentech are up 1.4% since Roche's initial July announcement.

If an unfavorable exchange rate, a diminished offer, and strength in DNA's share price weren't enough to kill Roche's chances at completing this deal, this morning's trading may have done the trick. After announcing falling profits in 2008, and a discouraging forecast for 2009, shares of the Swiss giant took their worst tumble in 11 years. Ironically, Roche was hammered again by the currency markets, as strength in the Swiss Franc against the dollar erased more than $2.75 Billion USD from revenues. Sales of the company's widely-known drug Tamiflu declined sharply as governments completed their stockpiling of the drug, and bird-flu hysteria waned. The result? The drug maker missed its guidance by over 10%, and the market erased more than $8.5 Billion USD from the company's value on paper. That's very good news for Genentech shareholders who want to avoid profit loss from currency exchange and Roche product weakness, and capitalize on the growing potential of the US company's future.

Despite the beating, executives at Roche didn't immediately back down. However, investors should anticipate a possible statement from Genentech today, as the effects of London trading reach US markets. Despite the long term benefits a weakening Roche provides Genentech shareholders, look for shares of the firm to be down in trading on the news, as the security of the Roche's previously stable offer evaporates.

When the dust settles, investors betting on the strength of US pharmaceuticals and biotechs will likely emerge healthy. I find it difficult to imagine a scenario wherein healthcare spending in the United States is reduced significantly, and the current government administration seems intent on fueling healthcare. The question is, where will Genentech fit in? Time will tell.