Genzyme: Geared for Growth

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From Standard & Poor's Equity Research

Leveraging Cash Flow

Genzyme has largely grown through acquisitions, building around its Therapeutics division, particularly Cerezyme. The company has made five acquisitions since 2004, and recently announced a potential sixth with the Bioenvision deal. This strategy is enabled, in our view, by a focus on operating efficiency, as Genzyme generated nearly $200 million in operating cash flow in the first quarter of 2007, after nearly $900 million in 2006. The company has built a global sales and manufacturing infrastructure, which we believe positions it to achieve sustainable high gross margins.

Another sign that makes us believe the biotech industry is maturing and operating more like pharmaceutical companies is the recent flurry of share repurchase plans announced by leading companies including Amgen and Biogen IDEC (BIIB), in addition to Genzyme. These companies, responding to potentially slowing growth, have chosen to leverage their cash flows to maximize profitability, while still making strategic acquisitions.

We believe that Genzyme is undervalued compared to its peers in our coverage universe. The shares recently traded at a p-e-to-growth (PEG) ratio of 1.2 times based on our 2007 EPS estimate, compared to the 1.4 times PEG enjoyed by the peer group. In our view, the shares are being discounted in part due to Genzyme's history of dilutive acquisitions, and the number of late-stage pipeline candidates that are nearing, but have not reached, approval. By our analysis, these candidates are not being valued fully on their market potential. We note that the proposed Bioenvision acquisition should be only slightly dilutive to Genzyme's 2007 earnings, and see future acquisitions being financed by the company's internal cash flows and, therefore, less dilutive to earnings.

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Our 12-month target price of $80 represents a p-e multiple of about 29 times our 2007 EPS estimate of $2.74 (and also a PEG of 1.4 times), putting Genzyme in line with the profitable, large-cap biotech peers in our coverage universe.

Our view of Genzyme's corporate governance is mostly favorable. We are encouraged that the company has a largely independent board, with only one inside director, Chief Executive Officer Henri Termeer, and no affiliated outsiders on the board. In addition, the compensation committee is comprised solely of independent outside directors, and all directors with more than one year of service own company stock. We also view the governance policy as transparent, with its guidelines publicly disclosed on the company's Web site.

On the negative side, we see board independence potentially constrained by the CEO's dual role as board chairman. CEO Termeer earned nearly $15 million in compensation in 2006, largely due to stock options. However, we believe that Genzyme's compensation structure is in line with the biotech industry, which typically uses options to attract and retain key personnel. Further, we believe that management has performed well in enlarging the company in recent years.

Risks to our recommendation and target price include clinical or regulatory setbacks to the new product portfolio, and any slowdown in sales growth for key products. We note the inherent risk in the biotechnology industry, as the landscape is increasingly competitive. However, we believe Genzyme has done well in pursuing next-generation versions of key products such as Cerezyme and Renagel.

Silver is an analyst for Standard & Poor's Equity Research.