Genzyme Case Study
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Henri Termeer started Genzyme Corporation with ten employees and then grew it to a corporation that now has four billion in sales per year. Genzyme is a biotechnology company that specializes in finding orphan drugs, which specifically cure enzyme deficiency conditions. To offer a brief explanation, an orphan drug is a pharmaceutical agent developed to cure a rare, orphan, disease. In order to find the cures for these rare diseases, technology using living biological systems and living organisms is used, which is known as biotechnology. In order for a biotechnology firm to succeed time is needed to give the firm the opportunity to find a successful product. According to Mr. Termeer, this requires that upon investing in a biotechnology firm you wait for results and the investment is long term.
Genzyme’s business model was to run the company just like a laboratory. The company aimed to avoid blockbuster drugs and focus on the treatment of genetic disorders. This causes the board of the company to be made up of other scientists, like Termeer. The company’s financial strategy is to reinvest gains into other biotechnology companies through capital allocation. Termeer’s motivation behind the acquisitions was to create medicines to cure more common diseases and to create a bigger group of people being aided by the company’s discoveries. The executives of the company are awarded bonuses based on their revenue generation and not on their profitability. When looking for companies to purchase the main outlook of executives was each companies revenue, not profitability. The company also chose in this goal to not give out any dividends to shareholders. All earnings were retained in order to reinvest them in the future growth of the company. The financial and business choices made by Termeer have positioned Genzyme to plateau in its own generation of revenue. Genzyme was being run as a laboratory and not a business.
Ralph Whitworth, the owner of a firm called Relation Investors, was the man who stepped in to turn Genzyme into a business responsible to its shareholders. Whitworth’s firm is known as a an activist investment firm, meaning it invested in firms that had cash flows not being correctly utilized. The executives at Relational Investors were trained to look at the financial statements of companies for whose discounted cash flow analysis showed a positive gap with the company’s market price. Genzyme was selected for this reason with the end goal of pushing the company’s cash flow up in order to raise the stock price and make a profit on the initial investment. This gap in the value can come from two different areas, the first being that the company is not spending money economically. The second is that the company is suffering from bad management and a board that does not hold them responsible. A company can be underperforming because of poor integration results with acquisitions or management incentives being skewed.
Once Whitworth invested into a company his main targets were management and board compensation. These, in the eyes of Whitworth, were the two areas that led to successful companies, but were the most fragile to approach with a targeted firm. Whitworth believes that executives can receive high pay, but only if they deserve the high pay. When looking to change a board, Whitworth either requests a seat on the board or starts a proxy fight. By gaining a seat on the board Whitworth can move to have board members ousted and then replaced with people that have financial and business experience. By starting a proxy fight other shareholders apply pressure to the board to make changes. Either option puts control into the hands of Whitworth allowing him to make the necessary changes to the company.
The first recommendation is to change the route of the capital allocation of Genzyme. Businesses that are in the genetics testing area should be sold off since they are long-term investments and are not beneficial to build immediate cash flow. Biotechnology companies take a long time to generate cash flow, which was pointed out by Termeer. When looking at cash flow, these are the worst companies to invest in because you have to wait ten to fifteen years for a return on your investment. Newly acquisitioned companies should remain under Genzyme but under the watchful eyes of the board. Moving onto the board new members are needed with better experience in business, not in the laboratory. Termeer would like the board to be composed of his friends who understand biotechnology, but financially it makes more sense to have businessmen on the board.
The next recommendation is to change the structure of bonuses for executives, which would be a sensitive subject for the board and Termeer. Incentives should be based on profitability of their work, not on their revenue generation. This will motivate executives to produce work that pushes up cash flow for investors. In regards to investors, a share buyback program should be initiated because Genzyme cannot use all of their returned earnings on reinvestment. Although Genzyme argues that cash is needed for future investments, a share buyback would be more beneficial to raise prices of remaining shares of stock. All of these recommendations are based on the text with outside research on definitions.