Roche Takes Its Medicine - Erich Hunziker, CFO, Roche

In March, earlier this year, Erich Hunziker, held a particularly important finance function meeting. Over 250 Roche and Genentech finance people gathered together for the first time since Roche’s acquisition of the US-based biotech firm in 2009.

Several topics were up for discussion. How could they make Roche finance a great place to work? How could they improve group reporting and forecasting? Hunziker believes finance usually provides too much data, so the ambition must be to distribute information rather than data points. Plus, there was a focus on process standardisation, process automation, and a shared service centre, or what Hunziker calls ‘the transaction factory’.

There was one other important question: where, asked Hunziker, did his finance people think they were on the S curve? Plot expertise against time, and you get the S curve. You invest in an activity, then harvest the benefits and finally, you attain wisdom. Then it’s time to move on to a fresh challenge. Organisations and individuals need to know where they are on the S curve, so they know when it is time to push the boundaries and move beyond their comfort zone to face the next challenge. Miss that moment and you risk being overtaken and left behind.

Roche shows no signs of being left behind, though. It might have, had it not taken on Genentech, or if it had botched the acquisition. Many mergers and acquisitions destroy value. But, far from being a bitter pill to swallow, the Genentech deal made perfect sense for Roche and it’s already benefiting Roche’s shareholders.

Diverting cash flow

Roche controlled the majority of Genentech from 1990. So if the pharma giant allowed Genentech to operate independently at arm’s length all these years, why the change?

"Ultimately, Genentech was a victim of its own success," explains Hunziker. "In the 1990s the company was a biotech innovation engine. Two-thirds of employees worked in R&D, and the company was focused almost exclusively on innovation. The result: it was one of the best output innovation engines in the world.

"But based on the blockbusters it created, Genentech built a huge value chain in the US. So, by the end of 2007, when we really looked at the situation, just 20% of the people were in the innovation engine and 80% were in general and administrative positions, marketing and sales. These areas of the business were not as uniquely biotech, but similar to big Pharma."

Indeed, Roche already had a significant presence in the US.

"We saw the duplication of the value chain," says Hunziker. "Both companies had several hundred people just in the IT systems for the US alone, for example. So there was huge synergy potential, just by bringing the organisations together, without sacrificing the innovation side of things."

Another important factor, says Hunziker, was the cash position. With Genentech developing several blockbuster drugs, notably oncology products Avastin, Herceptin, and Rituxan, its US rights agreements meant that cash flowed straight out of the US market to Genentech, adding to royalty streams for its products in other Roche territories.

"The major cash streams, which are really important for the entrepreneurial development of the group, were locked up in Genentech," says Hunziker. "Accessing that cash was extremely difficult, because there was a 44% minority shareholding. If we had dividended out the cash, there would have been a huge dilution to minority shareholders. Plus, the tax situation for dividending out cash was unfavourable at the time. If Roche wanted to develop as a global group we had to find a solution to access those cash streams."

Finally, there were contractual reasons favouring a change. The contractual agreement whereby Roche received the right of first refusal for Genentech’s products outside the US ended at the beginning of 2016.

Bold bond issue

Although it made good business sense, getting the deal done was far from straightforward. The deal was initiated in July 2008 and two months later Lehman Brothers collapsed – hardly the best time to raise finance for such a major acquisition.

"I was personally responsible for the financing, and we needed a massive SFr 48 billion," says Hunziker. "In a way, the fact that nobody trusted the banks at that time worked in our favour. A company like Roche was seen as a better counterparty risk than many banks or governments. I travelled around the world with a small team and without any banking support, visiting big potential bond investors.

"So I was quietly confident we could launch the bonds, because I knew the cash was out there. And while most of the banks were against doing it this way, it is worth noting that we successfully launched the largest bond issue in history by a Swiss company."

Despite never having issued bonds in the US, after a whirlwind three days of roadshow presentations, Roche launched over $16bn of bonds in the US. This was followed a week later by 20 billion in sterling and euros in Europe and another eight billion in Swiss Francs; the largest ever dollar-denominated US corporate bond issue and largest euro-denominated fixed rate bond issue.

Not only did Roche get this huge bond issue away, but it was structured so that the company will pay down its debt very quickly. "The beauty of this financing is the attractive maturity profile.

The banks wanted us to go down the traditional threeyear, five-year and 12-year route. But I knew we were cash rich and could pay down a lot over six and 12 months. By the end of March we will have paid down 25% of all the debt raised," says Hunziker.

"Everything up to two years is on a floating interest rate, because we believe interest rates will stay down for a certain time, but everything beyond that is at fixed interest rates. We have also swapped all currencies into US$, because we can repay the debt out of our US$ cash flow, so I didn’t want to take on additional foreign currency risk."

Financially, says Hunziker, the transaction is already accretive, even without the synergies, as profit streams are directed towards the Roche rather than the minority shareholders. With the debt raised via US legal entities, the debt financing is tax deductible in the United States.

Another issue for Roche was employee retention. "Innovation at Genentech comes from the people, and a major concern was that these people would no longer see their future in a big pharma company," says Hunziker.

Roche went out of its way to reassure the Genentech innovators that the change would be beneficial. At the same time, instead of the Genentech options normally due, but not vesting for three years.

Roche agreed to pay a retention bonus of an equivalent amount. The first part of the bonus was paid out in July 2009, independent of whether the transaction was going to be closed, with the second part due by the 31 March 2010. Roche also agreed not to touch Genentech compensation packages before January 2011. Roche retained well over 90% of all the innovators it targeted at Genentech, says Hunziker.

Smooth integration

The financing and employee retention issues were only part of the challenge that Hunziker faced, though. Integrating two large organisations was always likely to throw up problems. But where many companies might have imposed systems and processes on the acquired organisation, Roche was remarkably laissez faire in its approach.

A number of principles governed the integration activities, says Hunziker. The company decided not to use consultants.

"We knew from experience that while using consultants in a process like this can have benefits, reducing politics for example, it doesn’t provide the same level of direct responsibility for the people who have to work with the integrated solutions."

Hunziker brought together the best finance people from both sides, under the guidance of a steering committee, to thrash out what financial practices would be used across the group.

"The guidance we gave was that, if you have one solution at Genentech, and another at Roche, you have to negotiate until you choose one of the two solutions,” says Hunziker. “Compromise was not an option."

Hunziker also mixed up leadership teams.

Just days after closing the deal I made job offers to about five or six key people at Genentech, to come over to Switzerland, and I motivated some bright eople from my team to go over to Genentech.”

However, not everything was up for negotiation.

"In treasury we have forex systems and cash pooling systems working across 140 countries. There, Genentech USA was just an additional country; within two months everything was fully integrated, just following the global rules, no discussions," says Hunziker.

"That’s at one extreme. In other fields Genentech had more advantages and innovative solutions, so we tried to learn from them." The future for Roche looks healthy as it emerges from the Genentech acquisition transition period. While much of the work is done, the integration is still ongoing.

The benefits are already apparent though.

"We have announced to the market that we have one billion in sustainable synergies from this transaction," says Hunziker. "Traditionally, you have three times the value of the permanent synergies upfront as a one time cost. So the cost is in the range of three billion Swiss Francs for whole transaction. By the end of 2011, the synergies will be a permanent one billion per year."

And what of Hunziker’s S curve? "Given my additional IT responsibility (he assumed group responsibility for IT in January 2010), I can definitely say that I am at the beginning of my next S curve in IT," Hunziker says.

"I have always been driven by challenge, by creating things. Sure, some people may consider finance and IT boring, but the company’s results will only be good if our finance and IT are state-of-the-art. You really are at the heart of value creation in these two fields."