In-network benefits

Unlike other big drugmakers facing do-or-die pressure to merge, Switzerland’s Roche has found a third way: Invest in a web of research partners and diversify into diagnostic equipment.

Four years ago Swiss pharmaceuticals maker Roche Holdings appeared to be headed for oblivion. With the industry consolidating into fewer and bigger corporations with enormous R&D budgets, midsize Roche seemed a sure acquisition target for one of its larger competitors -- its Basel, Switzerlandbased neighbor Novartis being the odds-on favorite. The two Swiss families that hold a 50.1 percent voting interest in Roche, however, had different plans. The Hoffmanns and Oeris repeatedly rejected overtures from Novartis and chose to keep Roche independent.

Good idea, as it turns out.

Today the industry’s three giants -- GlaxoSmithKline, Novartis and Pfizer -- are all struggling to varying degrees in the aftermath of major acquisition sprees. But Roche, under the leadership of CEO Franz Humer, 59, has graduated from takeover bait to one of the best-performing companies in the industry. In the first half of 2005, sales increased by 14 percent year-over-year, to Sf 16.6 billion ($12.9 billion). Net income slid by 4 percent, to Sf 2.8 billion, because 2004 results were inflated by a one-time gain from the sale of Roche’s consumer businesses. Excluding these items, earnings rose by 28 percent.

And while the shares of some bigger rivals have been held back by the controversy over health risks related to pain medications, such as Merck & Co.'s Vioxx and Pfizer’s Celebrex, Roche’s American depositary receipts are up nearly 30 percent since early February; they have more than doubled, to $66, since the beginning of 2003.

Roche’s secret? Its lineup of cancer drugs, which accounted for 35 percent of its pharmaceuticals sales last year. The company has built one of the industry’s most innovative and collaborative research groups, most notably with its 1990 acquisition of a majority stake in San Franciscobased biotechnology concern Genentech, which has developed such hugely successful oncology treatments as Avastin, Herceptin and Rituxan. Roche’s holding, now 56 percent, is worth about $50 billion, courtesy of a stratospheric rise of more than 2,800 percent in the price of Genentech shares since the acquisition. But more important than the value of the investment, Humer says, is how Genentech has augmented Roche’s research prowess and drug pipeline.

A native of Austria who has a law degree from that country’s University of Innsbruck and an MBA from Insead in Fontainebleau, France, Humer has spent 32 years in the drug industry. He joined Roche in 1995 as head of its pharmaceuticals unit after stints with Schering-Plough Corp. and Glaxo. He became CEO in 1998. Humer recently spoke with Institutional Investor Contributor Andrew Osterland.

Institutional Investor: You obviously have a valuable strategic relationship with Genentech. Do you ever look at how much your stake in the company is worth and feel tempted to cash out?

Humer: No, never. There’s no doubt in my mind that Genentech will continue to build value, because it has a unique model of innovation. The whole Roche group will profit from that. We have a majority shareholding in the company, but it is operated at arm’s length. We do the same with Chugai Pharmaceutical Co. [Roche acquired 50.1 percent of the Japanese biotech company in 2002.]

Beyond outsourcing R&D, what is the strategic benefit of these relationships?

Genentech, for one, has helped Roche to understand a different culture. We have different specialties, so we have formed a joint research committee. Our scientists meet regularly and exchange information and knowledge about disease. People from both companies can learn new approaches that they otherwise might not have considered, or certainly not as quickly. That’s a competitive advantage because we can quickly transform science into products.

What has driven Roche’s recent financial performance?

The growth in our sales and profitability has been driven by the success of new products. We had some difficult years between 1998 and 2001 as we were building our pipeline, but now we have very strong drugs in oncology, immune-system suppression and virology. And since we acquired Boehringer Mannheim Group in 1998, we have built the world’s leading diagnostics business, with a market share of 20 percent and increasing margins.

Is Roche now big enough to survive against larger competitors?

We are certainly big enough. Our business is about more than size, though. It’s driven by innovation. We now spend close to $5 billion per year on R&D. That’s way above any minimum critical mass necessary. If you double that research investment, there is no proof that your output will go up 100 percent. More important than just being big is making sure that you organize your research effort and motivate your researchers properly and that you are able to tap into pools of intelligence around the world.

How important are your research partnerships with outside parties?

We now have research and licensing agreements with some 70 partners. Outside relationships are essential for one reason: Research has become so complex that there are no longer monopolies on knowledge and innovation. We have to keep our eye not just on what we do in our organization but on what’s happening in the rest of the world. Today we spend between 20 and 30 percent of our research budget with third parties.

The majority voting control of Roche by the Hoffmann and Oeri families has protected you from takeovers. Has it ever hurt the company competitively?

It has never hindered the development of the company, and it has never stood in the way of what we wanted to do. On the contrary, it has given us the ability to implement long-term strategies.

Do the recent examples of serious side effects of some drugs, such as Vioxx, suggest a failure of regulatory oversight?

No. I don’t see any fundamental flaws with the system. The [U.S. Food and Drug Administration] and European agencies are the most competent regulators of drugs in the world. Sometimes a drug produces side effects that haven’t previously been seen. There is always room for improvement in the postmarketing surveillance of drugs, especially as new technologies emerge. But we can’t create a risk-free society. If we want progress and new drugs that can defeat disease, we need to take risks.

What do you think about disclosing more details about clinical drug trials?

I like the idea. We don’t have anything to hide. Beginning in April we started publishing the protocols and results of all phase two to phase four clinical trials on the Web. But we do have to be careful that these things do not slow up innovation.

How could disclosure curb innovation?

You have to be careful how this data is handled and analyzed. There can be sensitive information of a competitive nature involved. Another concern is that trials are sometimes equivocal, and the financial community is not that skilled in the analysis of those trials. If analysts come up with the wrong conclusions, it would be detrimental for the product, the company and probably the patient.

How do you respond to growing criticism in the U.S. that drug prices are too high?

It’s the wrong focus to talk only about price. We need to talk about value and price. From the patient’s point of view, if Roche can reduce the relapse rates of breast cancer by 50 percent with our drug Herceptin, it has enormous value to society. The U.S. and European health care systems are totally different. In Europe it’s the most controlled industry in the economy, and drug prices are determined by the government. However, we get the same prices for oncology drugs in Germany, Japan and the U.S., because we deliver value.

What’s your view on whether health care should be run by the government?

There are advantages and disadvantages to state-run health care systems. In Europe, with state-run systems, we don’t have the problem of millions of uninsured people, but we also have slower access to innovation. It can take two or three years longer to access the best available treatments in the market. The competitive system in the U.S. drives innovation. It created the biotech industry. About 60 percent of all drug research is now done in the U.S., whereas ten years ago Europe accounted for 70 percent. We’ve seen a significant brain drain to the U.S.

What’s the next big thing in pharmas?

Individualized health care is the future of medicine. The one-size-drug-fits-all idea will not apply in any disease category in 30 years. We are moving toward more-customized treatments by integrating molecular diagnostics into a number of our research projects. Our DNA diagnostic chips enable doctors to determine how well patients might metabolize certain drugs. They can then adjust dosages and make informed decisions about whether to treat aggressively rather than relying on trial and error. This is a fundamental step forward in the progress of medicine.