At Churchills Bar in San Francisco in 1975 Robert ‘Bob’ Swanson and Herbert ‘Herb’ Boyer both agreed terms on a coaster after several beers to invest together in a partnership which eventually became Genetic Engineering Technologies – Genentech. 34 years later that $500 investment was valued at over $5.8B a CAGR of 98%. What makes this story even more amazing is the gumption and tenacity of Bob and Herb to cut their own path forward despite many challengers and naysayers.
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The insights from this book have been drawn from Genentech – the beginnings of biotech by Sally Smith Hughes
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To first put the medical impact of Genentech in perspective. Genentech essentially commercialized genetic engineering (recombinant DNA technology). This is molecular cloning of foreign DNA into bacterial extrachromosomal DNA elements that can be grown in bacteria. These elements can be retained and transferred to the next generation of cells. This technology is widely used in the food we eat (Crop survival) and the medicines we need to survive (Vaccines & Pharmaceuticals).
The founding of Genentech
Bob Swanson after being fired from Kleiner Perkins (A now famous Silicon Valley VC fund), found himself out of work and with little savings. At the end of 1975 he found himself unemployed and living on unemployment cheques of $410 a month:
“my half of an apartment in Pacific Heights was $250, my lease on a Datsun was $110 and the rest was peanut butter sandwiches”
Swanson continued coming back to the idea he came across while at Kleiner Perkins called Recombinant Technology. After interviewing at 4 companies a day for 4 months he decided to pursue this idea to create something of his own. Swanson proceeded to cold call every scientist on a conference list to ask them if they thought this technology was ready to commercialize. After everyone told him it was two decades away from being ready, he came across Herb Boyer (one of the inventors of the technology). Boyer who was busy said he had no interest, but Swanson persisted and eventually got 10 minutes at 5pm on a Friday afternoon. This now famous meeting extended to 4 hours at Churchills bar where the deal was struck.
Swanson and Boyer agreed to invest $500 each to cover the legal costs. After this partnership was founded Swanson went to work on raising $500,000 in working capital with a 6 page business plan to develop the concept. Eventually Swanson returned to Kleiner Perkins and raised $100,000 and converted the partnership to a company which had three shareholders:
20,000 shares – Kleiner Perkins
25,000 Shares - Bob Swanson
25,000 Shares – Herb Boyer
70,000 Shares at $5.00 per share last raising price equating to a post raising valuation of $350,000 in April 1976 and Genentech was born.
Getting on board Genentech
Swanson successfully attracted high quality scientific talent to Genentech using an obscure method of offering stock options for scientific staff. In those days only management owned equity. Swanson believed that equity ownership would encourage longevity, which it successfully did.
The other key thing that Boyer did to secure top quality scientific talent was insist that Genentech continue to publish its work, which helped attract the best scientists who crave peer recognition. It also greatly assisted with quality control of internal work:
“…publishing our work helped validate the company in the eyes of potential customers and ensured we were doing good science by passing the muster with referees. It aided us with recruiting the best and the brightest because traditionally in the pharmaceutical industry trade secrecy trumped publication”.
Boyer and Swanson were very focused on getting the best people possible, and they pushed the staff very hard famously quoting “if you don’t have more than enough on your plate you’re not trying hard enough!”. Swanson was commonly observed as having a high sense of urgency instilling a “get shit done” culture where scientists worked very long hours and late nights for long periods of time.
In 1977 Swanson launched the second capital raising. Kliener Perkins invested a further $100k among 5 other funds that invested in February of that year. Taking total issued capital in the company to $950,000.
In August of 1978 Genentech signed a multimillion-dollar 20-year research agreement with Eli-Lilly in return for their right for worldwide distribution, manufacture and marketing of Human Insulin. Eli-Lilly ended up doing extremely well out of this licensing deal, having paid a total of $3M in upfront and milestone payments and an 8% royalty whilst collecting Billions of dollars from the sales of the product. For Genentech though, the main win was the endorsement of recombinant technology. Genentech then extended the team from only 8 staff members to over 26 to begin ramping up the development.
Swanson firmly believed that only by making and selling your own pharmaceuticals could you capture full monetary value to invest sufficiently in R&D to continue further development.
The IPO
In late 1979 it was estimated that there had been ~$150M of invested capital in industrial biology, contrast this to the founding of Genentech where the industry shunned the idea. A year or so later there were more than 100 US companies evaluating and conducting recombinant technology. This all lead to extreme interest in Genentech which was seen to be the innovator of the industry.
The recombinant technology achievements of Genentech were astounding however they were yet to demonstrate a financial return for investors. Famously Tom Perkins of Kliener Perkins attempted to sell Genentech to Johnson & Johnson for $80M. This was rejected. Later in 1979 Perkins and Swanson again attempted to sell Genentech this time to Eli-Lilly for $100M. This too was rejected despite the long standing commercial partnership between the two companies.
The appetite changed dramatically after President Nixon’s War on Cancer was announced and focused attention on Interferon, which was successfully replicated by Genentech and signed a letter of intent with Roche to develop bacteria producing interferon. With its mystique of cancer cure worldwide attention was drawn to Biotechnology. In 2005 Interferon sales from all manufacturers reached worldwide sales of $5B. In late 1980 it was estimated that over $1B had been invested in recombinant DNA technology.
There was considerable debate and the only real quarrel Swanson and Perkins ever had was the decision to complete an IPO of Genentech. It was a huge amount of additional work but Perkins insisted on being the first to list and cementing leadership in the industry.
During the run up to the IPO there was a very pivotal legal impediment to Genentech’s valuation, the Diamond v Chakrabarty case on the patentability of live organisms which was scheduled for court hearing in Spring of 1980. This case was of immense importance to recombinant DNA technology as it resulted in a backlog of ~100 patent applications and forced the likes of Genentech to proceed with research without the opportunity for exclusivity. In June 1980 the supreme court found that the human made invention was patentable as it did not occur in nature and was man made. This decision has become the cornerstone of biotechnology law and vital to attracting capital to biotechnology assets.
In late 1980 Genentech prepared the preliminary prospectus for IPO. In September of 1980 the pricing range was determined at between $25-$30 per share which was $190M - $225M. The SEC approved an issue price of $35 per share or $263M market capitalization. At this time Genentech was making $3.5M of revenue (75x). Genentech completed its IPO in September and on October 14 1980 the stock started trading, it promptly rocketed from $35 to $80 per share and closed the first day of trade at $75 or $550M market cap. Tom Perkins recalled it was the hottest stock offering in history at that time. The result for the founding shareholders was astounding, both Boyer and Swanson held 925,000 shares a piece (12% of the company each) valued at $70M each.
The takeover
The success of Genentech was largely Swanson’s insistence on product focus and fiscal responsibility. He focused scientific objectives and business objectives to move constantly towards products, patents and profits. This focus is a common thread among the most successful biotechnology businesses in history. It is crucial to have a business mind involved in the stewardship.
By 1985 the biotechnology industry had attracted over $3B of capital. In 1990 Roche acquired 60% of Genentech for $2.1B, the remaining 40% was acquired for $46.8B in 2009. In FY08 Genentech reported a Net Profit of $3.6B so it would appear the acquisition was only 13x multiple seemingly quite cheap. Genentech profits grew at a 44.5% CAGR from 1980 to 2009 when it was taken over ($81k - $3.6B). At the time of the 56% Acquisition Roche was ridiculed by the market for overpaying, however as you can see below the revenue of Genentech accelerated significantly and proved to be an exceptional transaction:
This was an absolute blockbuster year for biotechnology with Pfizer buying Wyeth for $68B, Merk buying Schering-Plough for $41B and Sanofi takeover of Genzyme for $18.5B.
Investment performance
The investment performance of Herb Boyer and Bob Swanson’s initial $500 to own 12% of Genentech is among the best investments in history. It would have had a value of $5.8B as at the date of takeover in 2009. This would have been a CAGR of 98% over 34 years.
This highlights the astronomical value that can be created in the pharmaceutical industry with astute focused management over long periods of time. It was certainly worth Herb Boyer picking up the phone on that late Friday afternoon in 1975 to meet with young Bob Swanson!