Can Genzyme Cure Investor Jitters?


In recent weeks, biotech investors have suffered their own case of Enron flu. First, Ireland's Elan Pharmaceutical (ELN) lost 70% of its market value after investors began to question its accounting techniques. Now, Enronitis seems to have spread to Genzyme Corp., where shares of Genzyme General (GENZ), the tracking stock for the biggest of the company's three divisions, have tumbled into the $45 range. That's down some 20% since the beginning of 2002.

Quite a reversal of fortune for the fifth-largest biotech company in the U.S. Genzyme General was a juggernaut in 2001, when its share value increased by some 30% during a rough year in the stock market. The concerns stem from the tracking-stock structure -- a measure of just how hypersensitive investors are these days. However, most analyst say such worries are overblown, and the company could dispel them with a focused effort at explaining its accounting methods.

Confusion over its tracking-stock setup isn't the only reason the shares have tumbled, however. Sales of Renagel -- a drug for patients with end-stage kidney disease who are undergoing hemodialysis that the company acquired in September, 2000 -- have exceeded expectations. But lately, its momentum seems to be slowing. And although Genzyme has high hopes for another drug called Fabrazyme, a treatment for a rare, inherited fat-storage disorder, it's still under review by the U.S. Food & Drug Administration, though it has been approved in Europe. For these reasons, investors will be watching closely on Mar. 7, when the company discusses its outlook at its yearend earnings meeting.

APPROACH WITH CAUTION. Genzyme General's stock is certainly cheap by historical standards. It's trading at about 33 times 2002 earnings expectations of at least $1.40 per diluted share, off its historic price-to-earnings ratio of about 40. But some analysts say investors should approach this stock carefully for the time being. "In the current environment and with all the negative events people are anticipating, the stock won't turn until [doubts] are cleared from people's minds," says Weidong Huang, an analyst at Times Square Asset Management.

Cambridge (Mass.)-based Genzyme has three tracking stocks, one for each division. The idea is to unlock as much shareholder value as possible from each unit. Each business can then focus on distinct markets, and the share price of a profitable unit won't be penalized if other divisions are unprofitable. At the same time, the tracking-stock structure allows the profitable Genzyme General to continue receiving a tax benefit from the losses in the other units, since, although Genzyme has three stocks, it's still one consolidated company.

The Genzyme General unit has done just fine. It's the premier developer of drugs for rare genetic diseases and has been able to stay afloat in a largely unprofitable sector. Its niche strategy has delivered profits, and over the years its investors have done well. However, Genzyme's other two units, Genzyme Biosurgery (GZBX) and Genzyme Molecular Oncology (GZMO), lose money. Genzyme Biosurgery shares were trading at $6.26 on Feb. 27, up from $5.31 on Dec. 31. Genzyme Molecular Oncology is also up slightly so far this year, to $8.11 on Feb. 27 from $8 on Dec. 31.

"DIFFICULT MODEL." In this environment, though, investors are punishing anything that isn't easily understandable. Although a number of companies in a variety of industries have used the tracking-stock structure for many years, it still doesn't sit well with some analysts. "That's a little difficult model for me to handle," says Greg Aurand, co-manager of Orbitex Health & Biotech fund and Orbitex Medical Science fund. He fears that Genzyme's money-losing units have less incentive to move toward profitability if the losses continue to offer tax benefits. In its defense, Genzyme notes it has already signaled to analysts that it hopes the biosurgery unit will be profitable on an operating basis this year.

The company also points out that it has consistently provided full disclosure of its financials to investors. Beginning last year, Genzyme began to report an estimated tax rate at the start of each year in an effort to offer better guidance, says spokesman Bo Piela. For 2002, Genzyme says it expects its tax rate to be between 23% and 25%.

What really has some investors nervous is the threat of a coming slowdown in Renagel's sales growth. Genzyme General's strong stock performance in 2001 was largely driven by Renagel, which soared to $177 million in sales in 2001, more than triple its $56 million level in 2000. Genzyme is predicting an additional 47% to 58% increase, to $260 million to $280 million, in 2002.

FEWER TAKERS. While the company says the U.S. market for Renagel is only 20% penetrated, analysts are concerned that sales may be topping out sooner than expected. Renagel has a maximum market of about 300,000 patients, figures SG Cowen analyst Bill Tanner. However, about one-third of those patients are covered by Medicare, which doesn't pay for Renagel.

Of the remaining 200,000 or so, Tanner figures, 100,000 are already taking the drug, while the other 100,000 are taking a competing product. Tanner expects 2003 sales for Renagel to be about $381 million, a solid 36% increase from 2002 estimates. But the drug will continue to slow after that, he says: "It's a matter of the real robust growth being over."

Meanwhile, Genzyme is still waiting on FDA approval for its treatment of Fabry's disease, a rare genetic disorder characterized by kidney dysfunction. Transkaryotic Therapies (TKTX) also has an application in for a similar treatment. Both companies filed in mid-2000, but the FDA has yet to approve either drug, asking for additional information. Whichever company gets approval first also gets so-called orphan drug status -- seven years of marketing exclusivity.

CUTTING DEALS? Bear Stearns analyst Ronald Renaud says if Fabrazyme loses approval to Transkaryotic's drug, Genzyme's earnings will get hit by about $0.02 per share next year and perhaps "a little more in further-out years. However, it doesn't significantly dampen the long-term growth story," he says.

The problem with that logic, argues Orbitex fund manager Aurand, is that Genzyme doesn't have much else to fall back on in its near-term pipeline. Sales of its top-selling product -- Cerezyme, a treatment for the inherited metabolic disorder Gaucher's disease -- grew just 6%, to $570 million, in 2001 and will grow at a slower rate in 2002. Aurand argues that "it's up in the air what the [company's] next leg of growth will be.... They can't live off of Renagel forever." That drug accounted for 18% of 2001's total sales of $981 million.

Aurand thinks Genzyme should cut another deal like the 2000 acquisition of GelTex Pharmaceuticals, which netted the company Renagel. One smart move, he suggests, might be a buyout of BioMarin Pharmaceuticals (BMRN), with which Genzyme is developing Aldurazyme, a treatment for another rare inherited metabolic disease called Hurler/Scheie disease. That drug is expected to be approved and launched by late 2002, and plans now call for the two companies to split profits.

A "SMALL PART." Genzyme declined to comment on any acquisition plans. But it's optimistic about the outlook. It expects total revenues in 2002 to be in the range of $1.15 billion to $1.20 billion, an increase of at least 17% over last year. If Fabrazyme gets FDA approval, Genzyme forecasts that the drug will contribute $25 million to $40 million in 2002 sales -- just a "small part of the overall financial picture for Genzyme General," says spokesman Piela. The company admits that Renagel won't grow as fast as it once did, but over the next decade Genzyme expects sales to eventually hit $1 billion.

Given all that, investors interested in Genzyme should pay close attention to any details it provides at its yearend earnings meeting. Until the future is clearer, Genzyme -- unfairly or not -- may continue to take a beating. By Amy Tsao in New York


Steve Ballmer, Power Forward
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