What Now, Genentech Investors? - TheStreet

(Editor's note: Come see Adam Feuerstein at the Money Show in San Francisco. Adam will be speaking to attendees on Friday, Aug. 8, at 2:15 p.m. ("Biotech Investing for Individuals: How to Turn Geeky Science Into Fat Profits"); on a lunch panel on Saturday, Aug. 9, at 12:35 p.m. ("Tech and Biotech: Picks and Pans for 2008 and Beyond"); and on Sunday, Aug. 10, at 8 a.m. ("Biotech Investing for Individuals: How to Turn Geeky Science Into Fat Profits").



eventually completes the job of

gobbling up Genentech


, minority investors in the biotech sector's No. 1 company will have roughly $44 billion to re-invest somewhere else.

Where will all that money go?

The most obvious answer is right back into the other large-cap biotech firms like


(CELG) - Get Report


Gilead Sciences

(GILD) - Get Report


Biogen Idec

(BIIB) - Get Report

, which, in turn, bodes well for the sector as a whole. More on that in a second, but first, here's an intriguing, if not a fantastical, proposal: How about into a new, mini-Genentech?

A Mini-Genentech Spinoff?

Yes, it's probably too early to think about Roche spinning off a piece of the "old" Genentech into a new, publicly traded company, but the idea isn't totally far fetched. Moreover, it might solve the thorniest issue facing the Swiss drug giant outside of defending its $89-a-share takeover price: How to retain Genentech's best and brightest scientists so that they keep on discovering new blockbuster drugs for Roche and not for someone else.

Think about it, Roche is making its move now because it wants to control 100% of Genentech's commercial operations, namely the blockbuster products Avastin, Rituxan and Herceptin, before it has to renegotiate a new marketing agreement in 2015. The weakness in the U.S. dollar works to Roche's advantage today, and the company acknowledges that the environment for Big Pharma is changing, growing more competitive.

Genentech also has one of the deepest R&D pipelines in the industry, which should help Roche grow into the future, but if the company were interested in unlocking more of the value from that pipeline -- and could get investors to share the risk and reward of early-stage drug development -- a mini-Genentech spinoff (with Roche still controlling a majority stake, of course) makes a lot of sense.

And by partially spinning off Genentech's drug-discovery and early-stage drug-development operations into a separate, publicly traded company, Roche could reward Genentech scientists who stay with the favored currency of Silicon Valley. I'm talking, of course, about mini-Genentech stock options.

"What I like best about the mini-Genentech spinoff idea is that the company will be seeded with a pipeline that's truly vetted. It wouldn't be like most of these new biotech companies where all you get are some unknown compounds tested in mice," says Les Funtleyder, health care strategist at Miller Tabak and Co. who doesn't mind taking some wild stabs at prognostication.

Clearly, investors who made money with the old Genentech would surely flock to invest in the ground floor of a mini-Genentech. It's hard to imagine Roche having a hard time selling that deal to Wall Street.

Investing on a Genentech-less Wall Street

Anyway, it's just an idea. Returning to reality, what does happen to the $44 billion (or more, if Roche ups the Genentech bid) that will flow to Genentech's existing shareholders?

David Chan, portfolio manager of the $1 billion Jennison Health Sciences Fund and current owner of 12.8 million Genentech shares, says a portion of that money will be re-allocated into other health care and biotech stocks as growth fund managers look for new opportunities.

"If large, growth-oriented investors seek other biotech opportunities, it will be big-cap stocks like Celgene and Gilead Sciences that will most likely be the beneficiaries," he says.

Adds Miller Tabak's Funtleyder, "Health care and MedTech

medical technology are good places to look for growth these days."

But Chan cautions that not all of the investment capital generated by Roche's buyout of Genentech will necessarily flow right back into biotech or health care. "Growth investors look for growth, and for some funds, that will mean looking outside of health care stocks," he says.

At current prices, Genentech makes up roughly 35% of the $277 billion in total market cap from the so-called "Big Six" profitable, large-cap biotech companies, which include Biogen Idec,





(AMGN) - Get Report

as well as those mentioned above.

Genentech is the most widely held of the Big Six, so removing it from the list not only shrinks the sector considerably but also makes it less attractive to investors who owned Genentech because it was the "safe" way to gain biotech exposure.

"If the biotech sector's market cap shrinks by a big chunk, there is the possibility that general growth investors pay less attention to the sector," says a health care hedge fund manager.

Mike King, senior biotech analyst at Rodman & Renshaw, also sees potential downside for the sector if Genentech ceases to be, because selling large institutional investors on the idea that Celgene, Gilead Sciences or Amgen can fill Genentech's shoes as the sector leader is going to be a hard sell.

"It's going to be tough convincing generalists because no one but Genentech has the breadth and science and the know-how to translate science into breakthrough, blockbuster products," says King. Celgene, Gilead and the others are great companies, but they're more limited in scope, while Amgen is trying to diversify, but lacks the credibility of Genentech, he says.

Selling the $89/Share Offer

Meantime, Roche executives met with investors and analysts Tuesday in New York to further explain the rationale for taking Genentech private and to defend their $89-a-share offer. Roche executives were to meet with Genentech management, including CEO Art Levinson, on Tuesday night.

The consensus appears to be that Roche will have to raise the offer to make the deal work.

"Minority shareholders want to be treated fairly; $89 a share is not fair value," says Jennison's Chan, who believes a triple-digit offer would be much more palatable.

"This process could drag on for a long time, and if that happens, there will be lawsuits and Genentech people will leave and Roche will end up destroying Genentech's value. I think Roche knows this so it will make a higher offer," he says.

Rodman's King has an even better idea: Levinson rallies private equity buddies, including early Genentech funder and venture capitalist extraordinaire Tom Perkins, to raise money enabling Genentech to make its own hostile bid for Roche or otherwise buy itself out.

Says King: "If I were Levinson, I'd get in the face of

Roche Chairman Franz Humer and tell him, 'You don't buy us, we'll buy you, punk.'"

Adam Feuerstein writes regularly for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. Feuerstein appreciates your feedback;

click here

to send him an email.