A Cloud Clears for a Gene Mapper

If only all that mattered were the purity of one's intentions. Alas, on Wall Street, it's cash and the perception of cash that count. So Human Genome Sciences' (HGSI ) noble mission--"to treat and cure disease by bringing new gene-based drugs to patients"--hasn't inoculated its stock, now under $7 a share, after commanding $116 just three years ago.

Some relief may be near for shareholders in this pioneering genomics company. The reasons, bound up in accounting rules, are twisted enough to make DNA's double-helix look like the shortest distance between two points. But if you bear with me, I'll lay out why HGS investors may soon feel better.

Do you remember "special-purpose entities"? Made infamous by Enron, these off-balance-sheet financing vehicles let many companies fund all sorts of initiatives without carrying their assets and liabilities. SPEs can cut interest costs and often tax bills, too. Their allure wasn't lost on HGS, which used SPEs to finance some real estate projects. Even as Enron collapsed in the fall of 2001, HGS struck two such deals to pay for a new, $526 million office, research, and manufacturing campus near its Rockville (Md.) headquarters.

Yet unlike Enron, HGS plainly disclosed the deals' risks and terms, notably one that called for up to $526 million in cash to be set aside one day as collateral. HGS holds $1.5 billion in cash, and it isolated the cash-as-collateral on a separate line on the asset side of the balance sheet. Despite all this, after Enron, most any off-balance-sheet deal has become a rallying point for bears, some of whom contend HGS's cash hoard might look to some naive investors to be richer than it is. One short-seller told me: "They're going to be out of cash."

Such hyperbolic worry has not been focused on HGS alone. Critics hit Krispy Kreme Doughnuts (KKD ) last year for using an SPE to finance a new plant. It caved in and reverted to conventional financing. "There is no reason for us to do anything that could be misinterpreted, regardless of how legal and acceptable it may be," Krispy Kreme CEO Scott Livengood explained at the time. "The perception and confidence of our investors and customers is more important than the propriety of accounting vehicles." HGS came to the opposite conclusion and hung tough.

This surely is not all that weighs on the stock. HGS last year lost $220 million. Just the same, persistent doubt about the off-balance-sheet deals has done nothing to lift the stock out of misery. But now, HGS is being forced to act. In January, the Financial Accounting Standards Board issued rules that will move deals such as HGS's onto the balance sheet. Steven Mayer, HGS's chief financial officer, told me that he and auditors from Ernst & Young are still studying the new regulations, which may apply differently to its various SPEs. But the way its major off-balance-sheet projects are now structured, they would have to be consolidated with the rest of HGS's assets and liabilities. He added: "The trend is to put more on the balance sheet." HGS also has redesigned the new plant, cutting its cost by at least $75 million, and may refinance it conventionally.

So a cloud over HGS is evaporating. Putting HGS' plant expansion on its balance sheet would make its accounting harder to criticize. Yet it would not change HGS' net worth, now $8.54 a share. Even if, in extreme conservatism, you assume its new campus lost all of its value, net worth still would top $5 a share. Cash net of debt would come to more than $4 a share. Does this make me, a wary investor, want to buy HGS? No. It's expected to lose $1.68 a share this year, a real drain on the cash it needs to win approval for the eight drugs it has in clinical trials. But if someone tells you HGS has a problem with off-balance-sheet deals, well, that's over.

By Robert Barker

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