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Rating Action:

MOODY'S ASSIGNS A1 RATING TO GENENTECH, INC.'S NEW SR. UNSECURED NOTES; AFFIRMS PRIME-1 SHORT TERM RATING; STABLE OUTLOOK

13 Jul 2005
MOODY'S ASSIGNS A1 RATING TO GENENTECH, INC.'S NEW SR. UNSECURED NOTES; AFFIRMS PRIME-1 SHORT TERM RATING; STABLE OUTLOOK

New Debt Issue of $2 Billion.

New York, July 13, 2005 -- Moody's Investors Service assigned a rating of A1 to Genentech, Inc.'s new $2 billion senior unsecured notes. At the same time, Moody's affirmed Genentech's Prime-1 short term issuer rating. The rating outlook is stable. The proceeds will be used to refinance approximately $585 million of leases, and for general corporate purposes.

The senior notes are being sold in privately negotiated transactions without registration under the Securities Act of 1933 (the "Act") under circumstances reasonably designed to preclude a distribution thereof in violation of the Act. The issue has been designed to permit resale under Rule 144A.

The A1 rating reflects: (1) Genentech's preeminent position in the biotechnology sector; (2) a healthy outlook for growth in revenue, earnings and operating cash flow; (3) strong cash coverage of debt; (4) product concentration risk and unresolved litigation; and (5) Genentech's relationship with Roche Holdings, Inc. ("Roche"), which Moody's believes creates both positive and negative rating considerations.

The rating has been assigned in the context of Moody's Global Pharmaceutical Rating Methodology, which considers 15 risk factors reflecting both operating risks (such as revenue diversity and quality of pipeline) and financial risks (including profit margins and cash flow relative to debt).

According to the rating methodology, Moody's expects pharmaceutical companies rated in the broad "A" category to sustain cash flow from operations to adjusted debt of 40%-50%, and we believe Genentech will be able to solidly sustain or exceed this ratio. Moody's adjustments to Genentech's cash flow primarily include reclassifying tax benefits from the exercise of employee stock options as a financing cash flow (thereby reducing cash flow from operations and free cash flow). Adjustments to Genentech's debt include the estimated present value of operating leases, including a new synthetic lease Genentech entered in late 2004.

The outlook for Genentech's operating cash flow appears very strong, based on the success of products such as Rituxan, Herceptin and Avastin. Herceptin usage should increase following positive data in the adjuvant breast cancer setting, and Avastin -- approved for colorectal cancer -- is being studied for use in breast cancer and lung cancer. Moody's believes that Genentech's core products generate high profit margins, face limited exposure to patent expirations or to competition, and are unlikely to be significantly affected by changing reimbursement to providers.

Genentech also maintains a healthy balance sheet, with over $2 billion of unrestricted cash, short term and long term fixed income investments (net of equity investments) as of March 31, 2005. Genentech's cash and investments provide strong cash coverage of debt, i.e. adjusted cash and investments to adjusted debt, which Moody's anticipates will remain in excess of 100%.

Offsetting Genentech's credit strengths, the rating reflects product concentration risk (in Rituxan, Avastin and Herceptin), the anticipation of a free cash flow deficit for the next 12-24 months due to higher capital expenditures, and the uncertainty created by a DOJ investigation into Rituxan promotion. In 2004, Genentech's top three and top five products represented 59% and 71% of total sales, respectively. This level of product concentration risk maps to the "Ba" rating category in Moody's rating methodology.

Although very little information about the Rituxan investigation is currently available, Moody's notes that other investigations of this type have led to extremely large payments by other companies.

The A1 rating also considers Genentech's 56% partial ownership by Roche and other aspects of the relationship between Genentech and Roche. In some ways this relationship is negative for Genentech's creditors, because a maintenance of ownership agreement requires Genentech to repurchase large amounts of its stock on the open market to prevent dilution of Roche's ownership. In 2004, Genentech's net share repurchases totaled $847 million ($1.35 billion of repurchases offset by $505 million of stock issuances). Moody's believes these share repurchases will represent a very large component of Genentech's "free cash flow," especially in a scenario where Genentech continues to perform well and its employees exercise stock options.

However, Moody's believes that Genentech is highly important to Roche strategically, and that implicit support is provided by this relationship despite the absence of formal debt guarantees. Roche has licensed the international rights for key Genentech products including Rituxan, Herceptin and Avastin, and has the option to purchase the international rights for other pipeline products. Among Roche's five largest pharmaceutical products, two are Genentech products (Rituxan and Herceptin), and Avastin appears likely to become one of Roche's largest products. As a result, Moody's believes that Roche's success is heavily linked to the success of Genentech.

In light of the above, we believe the Roche relationship has positive and negative aspects that neutralize the impact on Genentech's A1 rating.

The rating outlook is currently stable, reflecting Moody's expectation of increasing cash flow from operations relative to debt, negative free cash flow in 2005 becoming positive in 2006, and maintenance of health cash coverage of debt.

To be considered for an upgrade in the future, Moody's would expect resolution of the Rituxan investigation, and demonstration that cash flow from operations to adjusted debt and free cash flow to adjusted debt can be comfortably sustained in the "Aa" rating level, i.e. 50% and 30% respectively.

Conversely, downward rating pressure could result under the following scenarios: (1) very large litigation payments, e.g. above $2 billion; or (2) less comfort that cash flow from operations to adjusted debt will be sustained in the 40%-50% range, such as through a problem affecting a core Genentech product or the issuance of additional debt to fund capital investments or acquisitions.

Ratings assigned:

A1 senior unsecured notes maturing in 2010, 2015, 2035

Rating affirmed:

Prime-1 short term issuer rating

Headquartered in South San Francisco, California, Genentech is a leading biotechnology company. Genentech reported $4.6 billion of net revenues in 2004.

New York
Patrick Finnegan
Managing Director
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Michael Levesque
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
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