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A Natural Selection

Darwin’s theory that only the strong survive may have been a prescient flash about giant Genentech and the cutthroat biotechnology industry. Now 16 years old, the concern has continued to outshine most younger, flashier competitors.

To hear Richard Bock tell it, perhaps biotech pioneer Genentech ought to hang it up. “They’re old hat,” says Bock a stockbroker for San Francisco-based Sutro & Co. “I’d rather talk about newer companies with a chance to make it big.”

But Bock’s observation is more a comment on the hype and expectation surrounding biotech than on the performance of Genentech itself. From the broker’s point of view, the San Francisco company has “limited upside potential.” Translation: An established star in biotech-the business of producing everything from growth hormones to cancer fighters by inserting genes into living organisms-Genentech doesn’t offer investors an opportunity for the quick kill. Fledgling companies do, particularly those raising millions in initial public offerings. But ask the heads of IPO concerns whether they’d trade places with G. Kirk Raab, Genentech ‘s president and CEO, exchanging their phenom status for that of a proven performer. The betting here is that 99 percent would make the swap in an eye blink.

Biotech humor holds that a company can consist of a mouse, a microbiologist, and a venture capitalist-and that it doesn’t need the last two to go public. But Raab’s Genentech-the first biotech company to make it big and the only one with three products-has come a long way from such “mad scientist” roots. With total product sales of $4.8 billion, the company has earned enough to keep its legion of researchers in rodents for life. But most important, Genentech is less dependent than its competitors on fickle investors, largely because of its decision in 1990 to sell 60 percent of itself to a U.S. unit of Basle, Switzerland-based Roche Holding, for $2.1 billion.

Ah yes, The Deal, called by some industry observers at the time “the Genentech solution.” Except that in retrospect, amid continuing consolidation in the drug business, swapping a stake for fresh capital has become the Genetics Institute solution, the Systemix solution-and, on the pharmaceutical side, the solution for industry titans Merck, Roche and Sandoz. Potential synergies have compelled each to snap up biotech interests. While the big players are skilled at the “D” side of R&D, Raab says, they remain lacking on the “R” side. “There is an entrepreneurial edge to the cultures at biotech firms,” he adds. Mergers and similar arrangements can be a `win-win’ situation.”

Many observers were stunned that Genentech dealt away a majority interest while relatively healthy. But the decision marked the company’s determination to grapple with issues that other maturing biotech firms are now beginning to confront. “The 80s was biotech ‘s period of promise,” says stockbroker Bock. “But for established players, the 90s will be the decade of reality.”

For Raab, one reality was the deep pockets it takes to bring a product to market. The price tag, he says, may run $300 million-timewise, that’s a minimum of seven years. At the time of the Genentech-Roche link-up, Wall Street’s torrid love affair with biotech had cooled, and Genentech was concerned about a shrinking market for Activase, its flagship anti-clotting agent used to treat heart-attack victims. Without the Roche deal, Raab insists, Genentech would have been forced to cut back on R&D and scuttle viable projects. As it stands, the company hopes to bring three new products to market by mid-decade, including DNase, a highly-touted treatment for cystic fibrosis.

Meanwhile, the transaction also signaled that the biotech game had gone global. The Roche deal gives Genentech access to the parent company’s vast, worldwide marketing apparatus. The partners recently launched a joint venture to market DNase in Europe, Japan and Latin America. But Raab aims to also use the arrangement as a springboard for other products overseas, where the approval process often is less tortuous.

In fact, even Genentech ‘s decision to elevate Raab to chief executive was a tacit acknowledgement that the company had come of age. Observers note that Raab was tapped to succeed company founder Robert A. Swanson as CEO largely because of his marketing expertise-of considerable value only to a global-minded concern with products to sell. Prior to joining Genentech, Raab was president of Abbott Laboratories. Previously, he had held marketing positions at Pfizer, A.H. Robbins and Beecham. Swanson has stayed on board as Genentech’s chairman.

The outlook for the company? Much depends on external factors. For one thing, the company’s $ 2,200-a-dose price for Activase puts it on a collision course with efforts to cut spiraling US. health care costs. The pricing decision also has left the product open to vicious competition from $ 1,700-a-dose Eminase, produced by SmithKline Beecham, and Astra Kabi’s streptokinase, priced at $200 a dose. So much is riding on this market for Genentech, it is shelling out $50 million for a study to prove Activase’s efficacy relative to other drugs. North American sales of the drug dipped 6.9 percent last year to $ 196.5 million. Its market share has declined in recent years from 65 percent to less than 55 percent. But Raab predicts flat sales of the product in 1992, and adds that the market has fully discounted any negatives related to Activase sales. In any case, Roche may be waiting in the wings, says Margaret B. McGeorge, an analyst at Sutro headquarters in San Francisco. The company has an option to buy an additional 15 percent of Genentech on the open market, and the remaining 25 percent on a sliding price schedule that starts at $45 and ends at $60 in April 1995, shortly before the option expires. Last month, Genentech ‘s stock price was hovering around 26, slightly above a 12-month low of 24 3/8. Revenues rose 8 percent in 1991 to $515.9 million.

Raab says he’s not peeking over his shoulder. If he has any serious reservations about the deal, he isn’t letting on. Did Genentech act hastily? The answer depends partly on when you ask the question. Last year, when capital-market funding was generous, the second guessers were out in force. But with each new consolidation arrangement-and each time the biotech sector undergoes a correction-Raab looks prescient.

“We have an arm’s-length arrangement with Roche,” says Raab. But amid continuing consolidation in the biotech industry, it’s one that may eventually become an embrace.

On a recent visit to New York, Raab stopped in to chat with CE editors about the biotech industry and Genentech’s future.

BRAVE NEW WORLD

Will biotechnology eventually help to decrease spiraling health-care costs?

Biotechnology will decrease the cost in that it will cut the time a person spends in the hospital with various ills. But it’s important to understand that over the long term, by saving life, there will be additional costs. Overall, health-care costs will go up as long as we have the relatively wealthy, healthy society we have in the United States.

When will we begin to see any such cost reductions?

I think we are already seeing them. A short list of the successful biotechnology drugs besides our own: EPO, an anti-anemia drug, and G-CSF, a cancer-fighting agent-both from Amgen, based in Thousand Oaks, CA.

There’s a peculiar psychology-a reticence-involved in the prices people are willing to pay for drugs. On the other hand, when life and death are on the line, most people say that cost is no object. How do these opposing factors work in determining the market prices for biotechnology products?

People do tend to feel that drugs are too expensive. In a sense, that’s odd, because the people upset because they paid $35 at the pharmacy for a prescription often are the same people that drive around in a Mercedes-Benz. But there’s an obvious reason for this: You can choose whether or not to buy a car. When it comes to taking a drug, usually there’s no choice. You’re buying it because something’s wrong, you’re sick and you need it.

So some of the emotional reactions to drug prices are understandable. But the reality is that drugs comprise only about 5 percent of the health care bill in the U.S. This figure is down from 8.9 percent in 1965.

Still, don’t some physicians, patients and industry observers question the high price tags on some biotech products?

In an emergency room, if someone comes in with a heart attack, the key thing is to save his or her life. I don’t care about costs, and I don’t think anybody else does, either. At that point, a doctor isn’t going to say, “What’s it going to cost to take care of that person?” In a time of crisis, it’s just not viable to debate the economy of giving someone an inferior $200 drug rather than a $2.000 drug.

That’s an interesting choice of figures, given that your Activase, priced at $2,200 per dose, is facing some competition from $1,700-a-dose Eminase, produced by SmithKline Beecham, and streptokinase, a $200-a-dose product put out by Astra Kabi. Doesn’t the cost-is-no-object approach apply only if a given product is clearly better than others on the market?

We’re spending $50 million on a study to prove Activase’s efficacy relative to other products. And we have additional clinical evidence-and much anecdotal evidence from physicians and patients-that our product saves more lives.

We conducted a survey of cardiologists and found that 98 percent of them said if they had a heart attack, they would want Activase. But the new survey will measure heart-attack products using a more rigorous methodology. If our product is proved to be more effective, then a $2,000 price is completely justified.

THE PRICE IS RIGHT?

Speaking more generally about the prices of biotechnology products, is it possible that over time they will decrease, as have consumer products created through other technologies, home electronics, for example?

The pricing of biotech products reflects the massive amounts of R&D it takes to bring them to market. The cost of the process has been estimated at about $300 million-timewise, that’s seven to 12 years-to discover and develop these drugs. We invest about 50 percent of our revenues in R&D.

When Sony comes out with a stereo component priced at $1,000, three years later you might see a comparable unit selling for $200. It is unlikely you will see that happen with biotechnology products. The reason: There is nothing driving the price down. Generally, what drives down prices are higher quality products that do a better job. In the case of electronics, for example, prices are more affected by what’s happening in the marketplace than by Sony’s costs.

Pricewise, perhaps the automotive industry offers a closer comparison to biotech. Historically, you see car prices going up, not coming down. The only time prices come down is either for a lesser quality product or when a manufacturer decides to undercut his competitors in a move to crack a new market or gain market share.

In September 1990, you decided to sell a 60 percent stake in Genentech for $2.1 billion to Switzerland‘s Roche Holding, parent of Hoffmann-La Roche. That was a time when Wall Street’s love affair with biotech companies temporarily had cooled. In retrospect, with biotech booming again, some industry observers have questioned whether you moved too quickly. Any regrets?

Monday morning quarterbacks always make perfect decisions. And to be sure, I have looked back and wondered whether I should have waited to make such a move. But to answer your question, no, I have no regrets. In fact, I think the arrangement we made was outstanding.

For one thing, we have remained independent. Roche has only two of 13 seats on Genentech’s board of directors. In most key areas, they must vote their shares along with the other minority shareholders. That arrangement holds fast even when it comes to electing other board members.

Besides, at the time we were facing economic pressures, partly because of shrinking profit expectations for Activase. The alternative for us was to significantly reduce our expenses. We reasoned that such a cutback would have significantly impinged on R&D spending-the lifeblood of any biotech organization.

We decided our shareholders would be better served by making the sale to Roche. They got a premium on their half of the shares, and the company got a capital injection of $500 million, a sum that has enabled Genentech to continue research on drugs to treat cancer, AIDS, inflammatory ailments and neurological diseases.

SCIENCE FOR SALE

Do you see your path as one that others are likely to follow?

Yes. There have already been a flurry of transactions under which biotech firms have decided to sell off a stake in themselves. Some specifics of these deals differ from ours, of course, but two examples are Genetics Institute selling 60 percent of itself to American Home Products for $666 million and the deal between Sandoz and Palo Alto, CA-based Systemix.

There are a number of factors that will drive continued consolidation. Larger pharmaceutical companies find very attractive the innovative, entrepreneurial edge in a biotech firm’s culture. Such a culture is essential to success in producing drugs. On the biotech side, the vast resources it takes to develop and bring a drug to market will force a further shakeout in biotechs and pharmaceuticals.

Would you have struck the same deal with an American company? Did the prospects of working with a Swiss company present any particular allure?

Very much so. Any Swiss company has an inbred international focus, because their home market is not their key market. So they know how to work with foreign subsidiaries. Roche has done that over the years with their units in Germany, Brazil and elsewhere in the world.

So with Roche you have a platform for expansion in Europe, particularly important ahead of the consolidation of EC markets at the end of 1992.

Of course, Roche has experience in registering the products with the European health authorities, and they have in place the necessary logistical and marketing systems. There’s a lot of things they bring to the table.

We’re currently setting up a joint venture in Europe to market DNase, to be used in the management of cystic fibrosis and chronic bronchitis. We’ll file with the authorities for approval in the first quarter of 1993 and we hope to get that approval by early 1994. We’re building our own organization: It’s a sales and marketing organization that is 100%-owned by Genentech. But it will work with Roche to market DNase in Europe, Japan and Latin America. There’s no commitment yet as to whether we would join with Roche to market any other products.

BATTLING THE BOTTLENECK

Let’s talk about the tortuous approvals process in the U.S. The Pharmaceutical Manufacturer’s Association warned in a recent newsletter that if the FDA doesn’t speed the review process, it could take 13 years to get to market 21 products on which approval is pending. How to best battle this bottleneck?

Things are looking somewhat brighter, partly because FDA commissioner David Kessler has changed his priorities. He said that last year was his year of enforcement, but that this year will be the year of biotechnology. He’s added staff to speed the approvals process and make the agency more efficient in reviewing biotech products. In addition, the White House has also expressed interest in funding biotechnology.

What about specific product areas? From which areas are you getting-or do you expect to get-your biggest returns?

At this stage, both TPA and growth hormone are about hand in hand. That includes sales both outside and inside the U.S. But longer term, I think DNase will be even more profitable.

With the sale of your stake to Roche-and the possibility of other such deals-is there any possibility that American companies will lose control of biotechnology, as they did to some extent when the U.S. developed superconductor technology but Japan made more substantial strides toward commercializing it?

There’s a difference between transferring technology and selling an equity stake in a company. Roche has 15,000 employees in the U.S. They do much of their research and manufacturing in the U.S. The pharmaceutical business is a global industry, and Roche is as much a U.S. company as a Swiss company. So it’s only a question of who owns the equity. And I don’t think that makes much difference.

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