Big drug firms generate profits by investing in R&D in the hope that they can discover new breakthrough solutions to medical problems. The process tends to be lengthy, often spanning many years, and fraught with risk as relatively few experimental drugs actually reach the commercial stage. Governments grant patent protection for a limited period to enable firms to recover their investment plus a financial return sufficient to compensate for risk. Absent continuous R&D reinvestment, existing products are subject to competition from generic drug manufacturers when patent protection expires. Big pharmaceutical companies have the option of reinvesting in their own R&D operations or partnering with or acquiring smaller biotech firms with drugs at various stages of development.76 With patent protection expiring for many of their primary cash-generating drugs, big pharmaceutical companies are aggressively pursuing biotech firms to help replenish their “drug pipelines.” Having become commercially viable in recent years, gene therapy, a protocol in which defective genes are replaced by healthy ones, shows great promise for curing a variety of inherited illnesses. Advances in manufacturing, better product safety and efficacy, and a favorable regulatory environment make gene therapy a high-growth investment opportunity. A key milestone was achieved in 2017 when US-based Spark Therapeutics (Spark) secured Federal Drug Administration approval for treating an inherited retinal disease. Since then, more applications have been identified, with more drug companies placing big bets that gene therapy will become a major contributor to revenue and profit growth. The growth potential of gene therapy was not lost on Swiss multinational health care company Roche Holdings AG (Roche). Roche announced on February 25, 2019, that it had reached an all-cash agreement to buy Spark for $114.50 per share. The $4.8 billion purchase price represented a premium of 122% over Spark’s closing market value on February 22, 2019, immediately before the announcement. The premium size reflects a possible bidding war with Pfizer and Novartis, both of which have partnerships with Spark to develop drugs. Spark will operate as a wholly owned subsidiary within Roche Pharmaceuticals. By focusing on treatments for rare, inherited diseases, Roche expects to be able to command some of the highest prices in medicine. For example, Spark’s blindness therapy Luxturna is priced at $850,000 per patient. Roche is counting on new medicines, including gene therapies, to help compensate for patent losses on the firm’s $21 billion per year cancer medicines. The Spark deal gives Roche a proven platform for commercializing gene therapies. Although Spark’s primary drug offering, Luxturna, thus far has been a money loser, the firm does have royalty income from a deal with Pfizer. With the Spark deal, Roche could become more competitive in the hemophilia treatment market if Spark’s gene therapies prove effective. Even with the acquisition, Roche will not be first to market. Novartis has targeted gene therapy as an area of focus, giving it the lead on Roche. Novartis’s spinal muscular atrophy (SMA) medicine gained approval in 2019. In contrast, Spark’s top drug only started phase 3 trials in late 2019. In addition to being late to market with new gene therapy drugs, a risk to Roche is that its current sales of Hemlibra to treat hemophilia A, a genetic disorder that prevents blood from clotting, may be cannibalized. Roche is betting that Hemlibra and gene therapy are more complementary than substitutes. Furthermore, with Spark, Roche enters a crowded hemophilia gene therapy market because other firms also have gene therapies under development. Roche anticipates that the market will be large enough for multiple firms.

Question #1:

- What external and internal factors drove the merger between Roche and Spark Therapeutics?

- What options other than an acquisition could Roche have pursued? Speculate as to why they chose to acquire rather than to pursue other alternatives.

- What are the major assumptions implicit in Roche’s takeover strategy? Be specific.

- Speculate as to why Roche chose to operate Spark as a wholly owned subsidiary. What are the advantages and disadvantages in operating the business independently from the parent?

Answer rating: 100% (QA)

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