Houghton and Atkeson

Genentech -- Not What It Used to Be

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In late July 2008, Roche (RHHBY) offered to purchase the 44.1% of Genetech (DNA) it did not already own for $89 per share. Since the deal announcement, many analysts believed the offer price would escalate to north of $100 per share by the time the process was completed.

On Sept. 29, DNA was trading at about $90, down from $98 in the weeks following the deal announcement. And then, the credit markets went into deep freeze. With the Roche offer terms unchanged, DNA slid down into the low $70s, where it started trading this month.

Investors are clearly concerned that Roche will either be unable to pull together the $43-billion loan syndication to complete the deal or will require a significant time extension.

In the face of this uncertainty, the stock has climbed back up to $82 per share on refreshed speculation that the deal will be consummated, as well as positive news flow regarding DNA's valuation relative to its visible earnings growth, primarily driven by the company's top-selling cancer drug, Avastin.

Option investors believe the deal may eventually be completed, but not in the near term and not for a big premium above the originally announced deal terms.

Recent option activity in DNA has been highly concentrated in the 80 and 85 strikes. Clearly, some of the original optimism has faded as 42,000 DAN Dec 100 Call (DWNLT) contracts are likely to expire worthless today.

Looking into January, the single largest open interest line is the DNA Jan 110 Calls (DWNAB), with 43,000 contracts open.

These massive 100 strike, plus open positions, reflect more optimistic times. It has cooled even in the world of biotech.

While DNA is a blue-chip biotech firm with strong fundamental prospects, option investors are quietly letting us know they believe the big money win near-term is unlikely in the next couple of months.

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