Roche will have "opt-in" rights on Chugai's Phase II rheumatoid arthritis agent in the U.S. as part of the merger agreement between the two firms.

"Roche will have the right to opt-in on the marketing or comarketing of Chugai products outside Japan and South Korea for which Chugai seeks a partner," the companies said.

MRA, a humanized anti IL-6 receptor monoclonal antibody for treatment of rheumatoid arthritis, is in Phase II trials in the U.S. Chugai also hopes to pursue indications for Castleman's disease and multiple myeloma.

MRA is one of four Chugai projects in clinical development in the U.S. Another monoclonal antibody (humanized anti-PTHrP) is in Phase I for treatment of bone metastases and hypercalcemia of malignancy.

An oral antioxidant, BO-653, is in Phase II for treatment of restenosis in post-percutaneous transluminal coronary angioplasty patients.

GM-611, a motilin agonist for treatment of gastroparesis and gastroesophageal reflux disease, is also in Phase II. However, the trial has been on hold since May pending final review of results of rodent carcinogenicity studies.

Roche's agreement with Chugai follows the formula used by the Swiss company in its 1990 deal with Genentech.

As with Genentech, Roche will acquire a controlling interest in Chugai, but will stop short of outright ownership. In both deals, the regional affiliate (Genentech and Chugai) will retain commercialization rights over its pipeline in its home market, with Roche holding an option for the rest of the world.

Another parallel between the two deals is the financial complexity involved in the transaction.

As a first step, Chugai will spin-off its Gen-Probe diagnostics division in the U.S. The companies noted that Gen-Probe "competes with certain diagnostics businesses of Roche."

Roche will then commence a tender offer for 30 mil. shares (approximately 10%) of Chugai. The Japanese company will then merge with Roche's current Japanese division, Nippon Roche, at a ratio of 61:39. Roche will purchase shares in the new entity to reach an ownership position of 50.1%.

The value of the deal is estimated to be between $1.22 bil.-$1.56 bil. (155 bil.-198 bil. Yen) depending on the terms of the tender offer.

Roche is understandably eager to try to repeat the Genentech formula. During its Dec. 10 presentation to analysts in Basel, Switzerland, Roche noted that its original $2.1 bil. investment for a 58% stake in Genentech is now worth $17.2 bil.

That does not include the $1.9 bil. gross profit that Roche made when it exercised its call option on Genentech in 1999 and subsequently reissued the shares, nor does it include the impact of the Genentech pipeline on Roche's operating performance over the decade (¹ Also see "Roche Re-Opens Bank Account: Firm Again A Creditor After Genentech Sale" - Pink Sheet, 3 April, 2000., p. 18).

One important difference between the Chugai and Genentech transactions is that Chugai will be Roche's sole presence in Japan following the merger.

In the U.S., Roche continues to operate a directly-owned subsidiary apart from Genentech. While the Genentech pipeline has helped Roche remain one of the larger pharma companies in Europe, Roche has not been able to break into the top tier in the U.S.

In its financial presentations, Roche maintains that the separate ownership in the U.S. should not confuse the picture of the company: CEO Franz Humer explained during an Aug. 15 conference call that "we are really in that sense looking at Genentech sales as products which in the U.S. we simply sell through a different sales organization, but it is one Roche company" (² Also see "Roche puts Genentech in context" - Pink Sheet, 20 August, 2001., In Brief).

At the operational level, however, it remains difficult for Roche U.S. to break out of the hospital market. The company recently underwent a restructuring and is trying a more focused approach under new CEO George Abercrombie.

Roche's struggles in the U.S. illustrate a potential drawback of the regional affiliate strategy: Roche may have difficulty translating pipeline projects from one affiliate into commercial opportunities for another.

If Roche wants to make a major launch of a Chugai product in the U.S., the company may need to seek an additional copromotion partner. Roche recently announced a deal to have GlaxoSmithKline comarket and codevelop its Phase III osteoporosis therapy ibandronate, noting that it needed a collaboration "to take full advantage" of the drug's potential (³ 'The Pink Sheet' Dec. 10, In Brief).

The Chugai agreement signals Roche's commitment to remaining a significant global player, and its continuing fondness for the art of the deal.

Roche touted the effect the Chugai acquisition would have on its image as a global pharmaceutical company. "The Roche Group will rank among the world's top 10 pharmaceutical companies, up from number 12, with a market share of approximately 3.5%," Chairman Franz Humer said.

The company noted its history of significant merger activity, including Genentech in 1990, Syntex in 1994 and Corange/Boehringer Mannheim in 1998.

The deal also supports Roche's contention that the 20% equity stake in the company acquired by its Swiss neighbor Novartis will not inhibit Roche's strategic freedom (⁴ [A#00630200007], p. 11).

Roche becomes the first global drug manufacturer to make a significant strategic move in Japan during the current period of intense interest in that market. Roche maintained that the Chugai deal will give Roche "first mover advantage" in the Japanese market.

Soon after the GSK merger was completed, CEO J.P. Garnier suggested that his company was looking at making a purchase in Japan, but observed that the continuing high price-to-earnings ratios for Japanese companies would make a non-dilutive transaction difficult to accomplish (⁵ Also see "GlaxoSmithKline Is Mouthful But Still Hungry: Is Next Course Japanese?" - Pink Sheet, 26 February, 2001., p. 3).

GSK does have a placeholder down in Japan via a joint venture agreement with Shionogi. Although the initial terms of the agreement are limited to specific projects, GSK believes the possibility exists to create a broader partnership (⁶ Also see "GSK/Shionogi Joint Venture Will Have HIV Integrase Inhibitor In Phase II" - Pink Sheet, 30 July, 2001., p. 22).

Bristol-Myers Squibb has also said it intends to become "a major player in Japan" (⁷ Also see "Bristol Rx Expansion Plans Include Biologics Manufacturing" - Pink Sheet, 2 October, 2000., p. 19).

Roche is replacing Lilly as Chugai's key partner in Japan. The two companies formed a joint venture, Chugai Lilly Clinical Research Company, in April 1999 to develop select Lilly compounds for the Japanese market.

The Lilly joint venture was dissolved on Nov. 30. The projects under development (including fluoxetine, atomoxetine and the Icos erectile dysfunction agent IC351) will be transferred to Eli Lilly Japan by the end of 2002.

"The decision to end the contract was made primarily because Lilly's internal development capacity and capabilities at its Japanese affiliate have significantly improved since the creation of CLCR," Chugai said.

As part of the dissolution agreement, the terms of a 1995 contract allowing Chugai to promote the osteoporosis agent raloxifene were "modified to be more financially advantageous to Chugai."

For Chugai, the Roche agreement will significantly enhance its position in the home market. Chugai will emerge as the fifth largest pharmaceutical company in Japan, with combined 2000 pro forma sales of about $2 bil.

Chugai's access to the Roche pipeline in Japan will give it the opportunity to enhance that position.

The agreement also continues Chugai's two-decade long effort to break out of the Japanese market.

In the 1980s, Chugai established a toehold in the U.S. by licensing the ulcer drug sucralfate ( Carafate ) to Marion Merrell Dow.

The company hoped to build on that presence by launching a version of EPO in collaboration with Genetics Institute and Upjohn. However, Amgen prevailed in patent litigation and the compound was never marketed in the U.S. EPO represents one-quarter of Chugai's sales in Japan.

After the Roche deal, Chugai's R&D "will focus on oncology, bone, renal and cardiovascular diseases, with a number of compounds suited for global development and marketing," the companies said. Chugai has a total of 14 compounds in clinical development.

JPMorgan advised Chugai on the transaction, and Goldman Sachs advised Roche.

Roche Tries Genentech Formula In Japan: Chugai Deal Follows 1990 Model

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