A defensive Chugai move could still make sense for Roche

Rather like a large share buyback, the rumoured acquisition by Roche of the minority stake in Chugai that it does not already own looks like a defensive move, and should have stock market bulls asking why $10bn-plus is not instead being put towards biotech M&A.

But Roche is a notoriously cautious acquirer, and has signalled several times that valuations in the current market are stretched. Moreover, it has done selective cutting-edge takeovers of its own, like the $1.7bn move on Seragon, and there are several reasons why owing all of Chugai could make a lot of sense.

As ever, a conservative player like Roche will not want to overpay. UBS analysts wrote today that a 15% premium to Chugai’s Friday close would value the 38.4% voting stake that the Swiss group does not own at $12.4bn, and at this price the move could be “modestly accretive”; this morning, Chugai stock closed up 15%.

Could be plausible

The rumours started after the markets closed on Friday when Bloomberg reported that Roche and Chugai were in talks over a full buyout.

A terse denial followed, with Chugai stating that it was “in no way in the process of reviewing any plan to become a wholly owned subsidiary of Roche, nor discussing with Roche such a transaction”. UBS, however, reckons that the story could be plausible.

The most obvious benefit would be the cashflow effect of giving the Swiss group the remaining 38.4% of Chugai’s dividend.

Roche’s controlling equity stake already allows it to book 100% of Chugai’s revenue and operating profit, but for accounting purposes this is reduced so only 61.6% of the bottom line is recognised by Roche. Booking 100% of Chugai’s net profit might boost Roche’s stock if the market applies the same price/earnings multiple to an entity with a higher recognised profit.

But there are more tangible cashflow benefits too, and most have to do with actually being able to influence Chugai’s decision-making.

For instance, the Japanese firm runs a separate commercial operation, and has recently signed deals on marginal oncology assets with Helsinn and Zeltia. Shelling out to expand the Japanese group’s European operation makes no sense financially for Roche, which clearly already has a major presence there.

Other cost savings would include eliminating management overlaps and getting rid of the cost of a full Japanese stock market listing. Further, loading more of Roche’s costs onto an operation in Japan could allow the Swiss firm to book more profits in low-tax jurisdictions and cut its tax bill.

Odd timing?

Still, if the rumour is true its timing seems strange, especially seeing as Roche first bought a 50% interest in Chugai back in 2002.

A lockup on not taking the stake above 60% expired in 2012; Roche has thus had two years to pull the acquisition trigger without doing so – and during this time Chugai has become 148% more expensive.

As such at today’s market cap a Chugai acquisition would be only 0.4% accretive next year, and 0.6% in 2018, UBS analysts calculate, applying a 2.5% financing cost. This, however, excludes the value of additional synergies, which is what this transaction would ultimately come down to.

After all, Roche did manage to integrate Genentech after years of running it at arm’s length as a majority-owned business, though repeating the trick with a Japanese business could be a tall order. A huge cultural difference was the key reason for proceeding cautiously with Chugai so far.

Proponents of full integration must hope that after 12 years Roche has learned enough about Japan, and Chugai’s staff enough about their majority owner, to make the culture issue irrelevant.

To contact the writer of this story email Jacob Plieth in London at [email protected] or follow @JacobEPVantage on Twitter

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