Advantages and risks of acquiring the other 44%
Roche is seeking to acquire 44% of Genentech in addition to 56% that it has already owned. Owning 100% of Genentech can help Roche to strengthen itself and exploit Genentech’s resources. First, the old model that allowed Roche to develop and commercialize Genentech’s products outside the U.S is not valid anymore; if Roche and Genentech merge, Roche can share in Genentech’s intellectual property. Second, if Roche’s and Genentech’s operations are combined, the two companies can create value by cutting costs and streamlining operations. Furthermore, under the present ownership structure, Roche could not get Genentech’s cash directly; if two companies are merged, Roche can access to Genentech’s cash. Finally, the two companies would not be competitive anymore and become stronger in the market.
However, risk comes along with Roche’s acquisition. As Genentech has become famous for its strong culture and most of the minority shareholders are Genentech employees, there is potential risk that the squeezing out would result in destroying Genentech’s culture; therefore the merger might lose human capital through employees changing their jobs. Second, the valuation of Genentech might be mispriced and that Roche have to pay high premium. Third, of great concern is the financing risk. For the acquisition, Roche has to get the availability of credit to finance a $44 billion, which could be more expensive due to financial crisis and make Roche harder to cover the finance.
Estimated stock price
Step 1: To calculate WACC
1) Calculate cost of debt
Abstract from Exhibit 16 Treasury and Corporate Interest Rates, January 2007-January 2009
2) Calculate cost of equity
By using CAPM, we can calculate cost of equity as below:
Market risk premium
Beta of company
as of July 18,2008 got from Exhibit7
Beta of equity
beta of asset*[1+(1-t)*D/E]
as of July 2008,10 yrs got from Exhibit16
Cost of equity
treasury yield+beta of equity*market risk premium
3) Calculate WACC
Knowing percentage of debt and equity as well as costs of both, we can calculate WACC:
Step 2: To forecast of Cash Flow
We forecast the free cash flow for Genentech from 2010 to 2018 use the historical numbers for it. Firstly, we distinguish between the sensitive items and non-sensitive items. Secondly, the non-sensitive items will not change in the future; however, the sensitive items are growing by a percentage change. We use the historical numbers in 2006, 2007, 2008 to calculate the percentage change and we will adjust the proportion based on the economy. Then we will get the numbers over the next a few years.
Since we are projecting future growth, it is assumed that the company will grow at the same rate as it did during the past 10 years. Therefore this model works better for the companies that are relatively consistent performers. So after the year 2018, the cash flow will increase constantly at 2%.
Forecast of cash flow
Forecast of cash flow-Continued.
Step 3: To forecast Genentech’s price/share
Step 4: Negative Surprise--How has the financial crisis affect Genentech’s value? Despite financial turmoil from 2008, the demand for Genentech’s products would not be dramatically thwarted—it would still increase but at a slower rate. On the other hand, financial crisis would result in investors’ panic and dropping demand in the stock market, therefore leading to decreasing stock price estimation. Hence, we make an assumption that a negative market surprise...
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