Genzyme: Geared for Growth

S&P likes the biotech's diverse product pipeline and considers the shares a compelling buy

We consider Genzyme (GENZ; recent price $65.15) among the most diversified biotechs, with solid core product growth, a promising late-stage pipeline, and a strong financial position of nearly $1.5 billion in cash as of Mar. 31, 2007.

By 2009, we expect the company to have initiated, conducted, or completed 20 pivotal trials that could expand and further diversify its portfolio. We believe that success in just a few of these trials would help the company maintain our projected long-term growth rate of 18%-20% EPS growth.

We expect key new offerings—Mozobil, initially in transplant settings; Tolevamer in hospital-borne C.difficile diarrhea; and Renvela in dialysis indications—to launch within the next two years. In our view, these new products should help Genzyme to further move from sales of its mature flagship product Cerezyme. In the first quarter of 2007, Cerezyme accounted for 32% of total revenues. We expect Cerezyme sales to account for roughly 30% of full-year 2007 sales, down from 35%, 38%, and 42% in 2006, 2005, and 2004, respectively.

Enzyme Replacement Therapy

In addition, we are encouraged by the planned expansion of Genzyme's nascent oncology platform, acquired in 2004's purchase of ILEX Oncology, and with the proposed $345 million acquisition of Bioenvision (BIVN), subject to necessary approvals, with whom ILEX co-developed leukemia drugs Clolar and Campath.

We believe Genzyme shares are compelling at current levels and our 12-month target price is $80. The stock carries Standard & Poor's highest recommendation of 5 STARS, or strong buy.

Genzyme develops, manufactures, and markets therapeutic and diagnostic products. In its largest segment, Therapeutics, the company's lead product is Cerezyme, an enzyme replacement therapy (ERT) for Gaucher disease, a debilitating genetic disorder causing fatigue, anemia, and bone erosion. In 2006, Cerezyme sales totaled $1.0 billion (up 7% over 2005), representing 35% of total revenue, down from 38% in 2005. As Cerezyme is a mature product, Genzyme is pursuing a next-generation oral therapy for Gaucher disease, which recently yielded positive initial Phase II results.

Going for Next Generation

Other marketed ERT products include Fabrazyme, which was approved in the U.S. and Europe for the treatment of Fabry disease, a rare genetic disorder. Fabrazyme sales were $359 million in 2006, up 18% over 2005. Most recently, Genzyme developed Myozyme, for treating Pompe disease, a rare and often fatal disorder with an estimated worldwide patient population of fewer than 10,000. Myozyme was launched in the U.S. and Europe in mid-2006 and ended the year with more than 550 patients in about 35 countries.

The company's next largest unit, Renal, is led by Renagel, a treatment to reduce elevated serum phosphorus in patients on kidney dialysis. Sales in 2006 rose 23% to $515 million. In April 2007, Genzyme announced positive study data for Renvela, a next-generation form of Renagel, for which a New Drug Application has been filed and is under review by the Food & Drug Administration (FDA).

We see this field becoming increasingly competitive, as Amgen (AMGN: Buy; $57) recently acquired a midstage development drug that may challenge Renagel/Renvela by 2010. The other key drug in the Renal group is Hectorol, acquired in the 2005 purchase of Bone Care International, which treats secondary hyperparathyroidism in patients with chronic kidney disease.

Positioned to Benefit

The company's Transplantation unit markets Thymoglobulin, approved by the FDA to treat kidney transplant rejection, for which Genzyme has recently announced a major manufacturing expansion to meet expected demand. Its Biosurgery unit markets Synvisc—an injectable biomaterial to treat knee osteoarthritis by improving joint lubrication, whose marketing rights were reacquired from Wyeth (WYE) in 2005—with next-generation, single-injection product Synvisc-One in late-stage development. Other products include oncology drugs Clolar and Campath, acquired with the 2004 purchase of ILEX Oncology.

Total revenues were $3.2 billion in 2006, up 17% from 2005 levels. We project a 16% increase in 2007 revenues to $3.7 billion, and a further 14% advance in 2008 to $4.2 billion. As new products reach commercialization, we expect Genzyme to maintain a comparable sales growth rate in 2009 and 2010. We also believe that the company is positioned to benefit from expanded indications of existing products.

Using 2005 as the base year, we forecast Genzyme's EPS to increase at an annualized rate of 18%-20% through 2009, aided by gross margins near 78% and strong expense controls. Our 2007 and 2008 EPS estimates are $2.74 and $3.24 respectively (including stock option expense).

News on the Horizon

In our view, Genzyme's pipeline is among the most robust in the biotechnology industry. We foresee a number of catalysts in 2007 and 2008, from both new products and expanded indications of existing products, spanning all of the company's reporting units.

In the transplantation unit, we expect Phase III data for Mozobil—designed to improve the outcome of stem cell transplant procedures—around mid-year. Mozobil was acquired in 2006 with the purchase of AnorMed. The company has also cited Mozobil as having potential applications in oncology. In the second half of 2007, we expect Phase III results for Tolevamer in C.difficile diarrhea, a hospital-borne illness; news on the progress of single-injection Synvisc-One; and data on Renvela.

We are encouraged by Genzyme's focus on expanding its oncology program. During the first quarter, the company filed with the FDA to expand use of Campath to treat first line B-cell chronic leukemia, and, in May, 2007, announced completion of Phase II trials in multiple sclerosis. Campath is currently approved for chronic lymphocytic leukemia.

Merger Momentum

In May, 2007, Genzyme announced the planned acquisition of Bioenvision, with whom ILEX Oncology co-developed Clolar, for $345 million. We view this proposed acquisition as a sign of Genzyme's confidence for expanded indications for Clolar. At present, Clolar is approved for children with relapsed or refractory acute lymphoblastic leukemia. Both Genzyme and Bioenvision had been conducting separate trials for adult treatment, as well as for acute myelogenous leukemia. While there has been vocal dissent by several Bioenvision shareholders over the terms of the transaction, we expect the deal to close and view the pipeline diversification favorably.

In our view, the biotechnology industry is seeing an acceleration in merger-related momentum. We believe this trend will continue, given what we consider to be healthy corporate profit levels and cash reserves, and we see such companies continuing to seek ways to sustain or reignite sales growth.

Historically, large pharmaceutical companies have sought to deploy cash and leverage their cash flows by purchasing smaller companies to bolster slowing product pipelines. In recent years, the leading biotechnology companies have matured and are now generating significant cash flows, enabling them to act more like big pharma in their acquisition strategies.

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.

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