FOOL PLATE SPECIAL: An Investment Opinion
Genentech is one of the granddaddies of biotech drug making, along with Amgen and Biogen. But Genentech today has the most current products and richest drug candidate pipeline. Don't be misled -- as I was -- into thinking that the company has had losses since its July 1999 IPO. Accounting requirements show negative earnings, but the company's blazing.
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Investors might miss the great news if they overlook the fine print on the SEC filings or rely on financial service earnings reports, which show negative earnings due to accounting requirements.
Two key Genentech facts:
--As this chart shows, Genentech had an IPO in July 1999. But it was a public company long before that.
The company's first IPO sallied forth in October 1980. Failure of a drug candidate forced Genentech to sell a majority stake to Roche in 1990. Roche bought out the rest of the company in 1999 and, in a surprise move, reissued 19% of its Genentech shares in a new public offering.
--Genentech has been forced to recognize Roche's 1999 acquisition costs. This push-down accounting results in negative earnings.
In a story last month, I first stated that Genentech was doing pretty well for a company with no earnings for the past year. After the company called and a few sharp Fools emailed, I learned about the fine print -- push-down accounting -- and made the correction toute de suite. The company explains it this way:
"Roche's cost of acquiring Genentech is pushed down to Genentech and reflected on Genentech's financial statements beginning June 30, 1999. The effect of push-down accounting on Genentech's first quarter 2000 consolidated statement of operations include recurring charges for the amortization of goodwill and other intangibles, and costs related to the sale of inventory that was written up at the redemption."
Without the accounting treatment of the Roche acquisition, Genentech has earnings per share of $0.31 for the third quarter 2000, a 19% increase over third quarter 1999. The accounting requirements have no effect on the fact that the company's cash flow keeps increasing and that costs are down. The company is a profitable cash cow and well on its way to meeting its goal of 25% annual revenue growth through 2005.
Unlike Amgen (Nasdaq: AMGN), which relies on sales from two big drugs, Genentech has many successful drugs on the market. Its strategy, like that of genomics-based drug maker Millennium Pharmaceuticals (Nasdaq: MLNM) and many others, is to use biotechnology advances to reduce development costs and make money from a stable of profitable drugs. This avoids the ever-more-expensive chase for the $1 billion-a-year wonder.
Sales of Genentech's two flagship drugs, the Rituxan and Herceptin cancer treatments, are growing 62% and 52% year to year, respectively, and 15% and 9.5% quarter to quarter. The company's pipeline is full, and it asserts promising signs for the initial sales of recently approved growth hormone Nutropin.
Don't overpay
Nevertheless, the company is priced at over 120 times forward earnings of $1.24 a share. This reminds me of the statement attributed to Warren Buffett that he would love to own a pharmaceutical company -- it's a great business -- but he can't find one that is value priced. My colleague Brian Graney (TMF Panic) wrote a terrific story yesterday on the perils of overpaying in "Great Company, Bad Stock."
Investors searching for biotech investments will want to consider whether Genentech is priced to perfection and whether a current purchase would mean overpaying. They may profit from reviewing the principles we'll teach in the Fool's first Biotechnology Investing Online Seminar. Our faculty will send 15 lessons to your e-mailbox and help you separate the winners form the losers in biotechnology investing. Today's the last day to register!
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