Roche Holding AG: Funding the Genentech Acquisition
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1. Statement of the Problem
In the case Roche Holding AG: Funding the Acquisition, Roche and Genentech are interested in an acquisition. Roche is acquiring about receiving all outstanding shares of Genentech. Roche Holding AG is a Switzerland-based pharmaceuticals and diagnostics company. It discovers, develops and provides diagnostic and therapeutic products and services from early detection and prevention of diseases to diagnosis, treatment and treatment monitoring. The Company has two divisions: Pharmaceuticals and Diagnostics. It operates worldwide containing the United States, Western Europe, Japan and Asia-Pacific, among others. Diagnostics include five areas: Applied Science, Diabetes Care, Molecular Diagnostics, Tissue Diagnosis and Professional Diagnostics. It operates in five geographical regions: Europe, Middle East and Africa (EMEA); North America; Asia-Pacific; Latin America, and Japan. Genentech is an American biotechnology corporation. The acquisition during a time period where dramatic declines in American real estate prices and an overheated credit market were taking place.
World markets were also down by 45%. Also during this time governments were investing in financial institutions. Banks also lowered interest rates for a number of reasons. Despite the uncertainty in the credit markets, corporate transactions were awakening in the pharmaceutical industry. During the time of the proposed acquisition Roche owned about 55.9% of Genentech and was considering buying all the remaining shares of the company at different prices per share. Roche was going to purchase the remaining shares for $89.00 per share but later offered to pay $86.50 a share due to changes in the market, which would require $42 billion in cash. In order to pay for this, Roche plans to pay $32 billion of the required $42 billion through selling bonds at various maturities from 1 year to 30 years. Because there are various publicly traded bonds being sold, many of them are in different currencies. The currencies include the US Dollar, the euro, and the pound, and because there are three different currencies this will minimize exchange rate risk. The three investment banks hired to help sell this bonds are Bank of America, Citigroup, and JP Morgan Chase and Co.
2. Alternative Solutions
1. Bond Valuation
(Issuing equity to Genentech shareholders is not an option because Roche’s founding family would like to maintain control of the company).
3. Analysis of the Alternatives
The fundamental principle of bond valuation is that the bond’s value is equal to present value of its expected (future) cash flows. The valuation process involves the following three steps Estimate the expected cash flow
Determine appropriate interest rate or interests rates that should be used to discount the cash flows. Calculate the present value of the expected cash flows found in step one by using the interest rate or interest rates determined in step two. The credit rating for Roche is AA according the Standard & Poor, which is the second best rating in a bond valuation, proving that it will almost definitely meet whatever financial commitments there are. Roche has many bonds to sell so they have to determine which bonds will sell at a floating rate and which bonds will sell at a fixed rate. Usually short term or relatively short term bonds sell at floating rate and long term bonds sell at a fixed rate. With that being said we can assume that Roche will offer one and two year bonds at the floating rate, and three, five, ten, and thirty year bonds at a fixed rate. If the coupon rate equals the anticipated yield then the bond is at par. I assumed 5% as the coupon rate. Making the assumption that $1,000 is the par value, according to exhibit 5, which shows the annual yield rate to maturity in U.S. treasuries the yield rates would be as follows: 1 year- 0.34
2 year- 0.48
3 year- 1.35
5 year- 1.87
10 year- 2.85
30 year- 3.59
See Appendix for Bond Valuation analysis.
Discounted Cash Flow
The Discounted Cash flow can be used to determine the attractiveness of an investment opportunity. DCF discounts future free cash flow projections and to determine a present value, which is used to evaluate an investment’s potential. If this value is higher than the current cost of capital then the investment is ideal. See Appendix for DCF.
Our final recommendation for this case, doing a DCF analysis, and bond valuation would be to go ahead with the acquisition of Genentech. Roche has various bond-selling options as well as the debt that will be issued will be sufficient in providing the initial capital for the shares.
Re = cost of equity
Rd = cost of debt
E = market value of the firm’s equity
D = market value of the firm’s debt
V = E + D
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
Tc = corporate tax rate