Roche Holding AG (SIX: ROG.VZ) – market cap as of 03/09/2019: $233.86bn

Spark Therapeutics, Inc. (NASDAQ: ONCE) – market cap as of 03/09/2019: $4.32bn

Introduction

On February 25, 2019, the Swiss multinational healthcare company, Roche, announced that it entered into an agreement to buy Spark Therapeutics in a transaction that is valued at approximately $4.3 billion. The offer of $114.50 per Spark Therapeutics share signifies a 122% premium to the previous closing price and will be financed entirely by cash. The deal allows the firm to expand its capabilities outside cancer treatment, while simultaneously entering the novel field of gene therapy. Furthermore, the deal has been unanimously approved by the boards of both companies.

About Roche Holding AG

The company was founded by Fritz Hoffmann-La Roche in 1896 and shortly after became the first entity to mass-produce synthetic vitamin C. Nowadays, Roche is organized into two primary divisions – pharmaceuticals and diagnostics. The first division is subdivided into Roche Pharmaceuticals and Chugai, while the second division covers diabetes care, molecular diagnostics, professional diagnostics and tissue diagnostics. While Roche operates roughly 20 research and development sites across the globe, it also controls the American firms Genentech and Ventana as well as the Japanese business Chugai Pharmaceuticals. The founding family still holds the majority of voting rights and Novartis controls approximately one-third of the shares.

The firm has historically been very active in terms of M&A activity. In 2018, Roche acquired Flatiron Health, which specializes in cancer data analytics, for $1.9 billion. In order to expand the company’s oncology pipeline, Roche purchased Tusk Therapeutics in the same year for $759m. Additionally, Genentech bought Jecure Therapeutics, gaining access to highly effective inhibitors that combat inflammatory diseases.

In FY2018, the firm reported total revenues of CHF56.85 billion, which represents a 6.7% increase compared to the previous year. Roche announced a net income of CHF10.5 billion in 2018, compared to CHF8.63 billion in 2017. Operating cash flow also increased from CHF18.02 billion in 2017 to CHF19.98 billion in 2018. Lastly, the company was able to increase its diluted EPS from CHF1.26 to CHF1.53 during the same time period and again raised its dividend for the 32nd consecutive year.

About Spark Theurapeutics, Inc.

Spark Therapeutics was founded in 2013, based on the research conducted at Children’s Hospital of Philadelphia. The company employs over 350 professionals, who seek to develop gene therapies that cure retinal, liver and neurodegenerative diseases. Spark Therapeutics’ primary assets include SPK-8011, which treats haemophilia A, and Luxturna, the first treatment against a rare form of blindness, called Leber congenital amaurosis, to be approved by US regulators. Additionally, the entity secured over $1.0 billion in external financing to sustain the rapid growth of its programs and platforms.

In FY2018, Spark Therapeutics reported total revenues of $64.73 million, which denotes a 436.3% increase compared to $12.07 million in the earlier year. The company reported a net loss of $78.82 million in 2018, compared to $253.48 million in 2017. Additionally, operating cash flow improved from -$154.54 million in 2017 to -$70.56 million in 2018, while diluted EPS increased from -$7.63 to -$2.11 during the same time interval.

Industry Overview

The start of 2018 was big for pharmaceutical industry, with over $100bn worth of deals being made; the streak led by the mega $74bn Bristol-Myers Squibb – Celgene acquisition and the $8bn Eli Lilly – Loxo Oncology acquisition. Downward pressure on drug pricing, driven by the three main factors of loss of patents, rise of gene therapy and government policies and rise of generics, is perceived to be catalyzing the massive chain of deals happening in the sector.

According to a report by Evaluate, $251bn of sales risk being depleted between 2018 and 2024, owing to patent expires. In an attempt to battle this sales threat, biotech companies were seen over the past two to three years to spend billions to restock their pipelines before their existing blockbuster oncology medicines lose patent protection. In fact, Roche dominated pharma R&D spending in 2017 and 2018, with $9.2bn and $11bn respectively. Companies have also been targeting sectors or other companies in the same sector with high growth opportunities for acquisitions in order to diversify and strengthen their product portfolio. The trend of R&D spending may also be attributed to the rise of immuno-oncology since its first launches in 2014, largely centering on the PD-1 and PD-L1 mechanisms or checkpoint inhibitors. Checkpoint inhibitors for treating cancer are a type of drug that blocks certain proteins made by some types of immune system cells, such as T cells, and some cancer cells. According to a study by Apex Market Reports, over the next five years the checkpoint inhibitors for treating cancer market will register a 28.0% CAGR in terms of revenue, while the global market size will reach $20.6bn by 2024, from $4.69bn in 2019.

2018 witnessed scientists around the globe being largely concerned by the news of genetically edited babies in China, Lulu and Nana, using Crispr Therapeutics’ technology. However, Crispr gene-editing tool has since been hailed as the biggest biotech discovery of the century.  From 2016 to 2018, M&A deal activity involving companies focused on gene therapy and tissue engineering went from $1bn to $18.9bn, showing how large pharmaceutical companies are willing to pay up for gene therapies. Crispr Therapeutics, on 25 February 2019, announced that its treatment of its first human with its namesake gene-editing technology, sending its shares up 25 per cent. Increasingly more companies now want to place their bets by diversifying their drug portfolios as a hedge against downward pressure on pricing.

As for government policies, healthcare service providers are by far the largest B2B buyers of pharmaceuticals, accounting for 32% of total market sales. While government spending on medicines is slowing, the number of people in need of treatment is rising, especially among the elderly. Increasing numbers of patients in hospitals, coupled with rising public debt, are expected to underpin sustained government measures to curb health care expenditure. One such measure is to impose further regulatory pressure on pharmaceutical prices, since publicly owned hospitals are the key buyers of drugs.

Deal structure

The acquisition of Spark Therapeutics,  the U.S. biotechnology company, will be financed in an all-cash transaction with an agreed price of $ 114.50 per share. This represents a total transaction value on a fully diluted basis of approximately US$ 4.3 billion which corresponds to a premium  of 122% to Spark’s closing price on February 22 2019 or of approximately 19% to Spark Therapeutics’ 52-week high share price on July 9 2018.

The terms of the merger agreement specify that Roche will quickly start a tender offer to buy all outstanding shares of Spark Therapeutics common stock. At the same time the board of Spark Therapeutics will give a recommendation statement that Spark Therapeutics’ shareholders tender their shares to Roche.

The closing of the tender offer will depend on whether the majority of Spark Therapeutics’ outstanding shares will be tendered. In a second step merger, Roche will acquire all remaining shares at the same price of US$ 114.50 per share

The closing of the transaction is expected to take place in the second quarter of 2019.

Deal Rationale

Roche, one of the leading prescription drug companies in the league of pharma giants such as Novartis and Pfizer, has its drug portfolio dominated by oncology. Roche’s market share was forecast to decline by 14.5% from 2017 to 2024 with a compound annual growth rate of only 0.2%, lower than the 12% average for the other nine companies in the top 10, according to EvaluatePharma. The low growth is due to arise from expected biosimilar erosion of its key products such as Avastin, Rituxan and Herceptin, and the company being late to market in the PD-1/PDL-1 space with Tecentriq.

The acquisition of Spark Therapeutics is in line with Roche’s ongoing strategy to combat stagnancy. Roche was recently seen to make multiple deals in oncology, including acquiring Ignyta, gaining multiple novel oncology compounds, and acquiring Flatiron, a data analytics company focused on oncology health records. This trend may also be due to how cancer treatments are seen as relatively immune to pricing pressures, particularly in the US.

Spark, an early leader in gene therapy with its breakthrough blindness treatments and many more in its pipeline, is a bolt-on for Roche, which has a 50 times bigger market capitalization. However, Spark is expected to plug a gap in Roche’s portfolio, providing protection if rivals emerge to Roche’s hemophilia blockbuster Hemlibra. Spark is the only biotechnology company that has successfully commercialized a gene therapy in the US. Its gene therapy Luxturna, sold in the US by Spark and elsewhere by Novartis, is a once-and-done treatment for a disease that causes blindness. It is one of the world’s most expensive drugs although treating hemophilia with gene therapy could be even more costly. BioMarin, one of the rivals to Spark, was seen talking about charging up to $3m per patient.

Market reaction

On February 25th, after Swiss pharmaceutical giant Roche Holdings announced the acquisition of Spark Therapeutics, the shares of Spark (ONCE) catapulted 120.1% to $113.48. This price is close to the acquisition price of 114.50 per share which is a 122% premium to Spark’s closing price on February 22 2019. On the other side, Roche’s stock (RHHBY) dipped a 0.23%, near 34.60.

Although Roche is paying a significant premium, investors reacted positively not only towards gene therapy companies but towards the overall sector as well. “We see a compelling strategic rationale for Roche to acquire […] Spark for $4.3 billion cash as this is emerging as a key therapeutic modality lacked by the pharma,” Jefferies analysts explained.

Other gene therapy biotech stocks took some heat from the Roche-Spark deal, like UniQure(QURE) which experienced an increase of 34.3%, to 55.87 or Audentes Therapeutics (BOLD) that jumped by 11.4%.

Financial Advisors

Roche is receiving financial advice from Citi and its legal counsel from Davis Polk & Wardwell LLP. On the other side, Centerview Partners and Cowen are acting as financial advisors to Spark Therapeutics, with Goodwin Procter LLP as legal counsel.


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