Frederick Frank, born 1932 in Salt Lake City, and educated at Hotchkiss School, Yale University (’54), and Stanford Business School (MBA, ’58) is one of the most distinguished American investment bankers of all time. Always a protean innovator, he has worked in key areas of finance as a spectacularly successful dealmaker sequentially for Smith, Barney and Company, Lehman Brothers, Barclays Capital, PJ Solomon, Burrill & Company, and finally EVOLUTION Life Science Partners, over a half century career which is still flourishing. Frank is regarded as the first and most important investment banker to have focused on venture capital biotechnology and pharmaceutical companies in both the United States and Europe. He has been honored and awarded multiple times (examples are the Hall of Fame Award, The Biotech Meeting 1997, Albert Einstein Award from the Weizmann Institute of Science 2004) for creating original and dazzling financial structures and mergers, which have synergized innovative early-stage research-oriented companies with larger development and market-oriented pharmaceutical corporations. He was instrumental in devising and bringing to fruition, along with Dr. Dr. h.c. Henri B. Meier and Dr. h.c. Fritz Gerber, the Hoffmann-La Roche acquisition of Genentech in 1990.
In this interview with Xecutives.net, Mr. Frederick Frank talks about this classic deal, as well as several other deals he personally engineered through ingenious new venture capital techniques of putting together banks, Big Pharma firms and fledgling biotech firms, all in the service of value creation that resulted in life-saving new drugs and health care services. He discusses the challenges facing European firms in securing venture capital for long term projects, where cultural and mindset barriers at the university level result in the “best and the private” opting not to enter into the private sector and face significant risk in exchange for substantial rewards, something their American counterparts would never do.
Xecutives.net: Mr. Frank, you can look back at an interesting life in which you have also dealt in depth with money and with value creation. I would like to ask you, right at the start, what does money mean to you, to yourself? I would also like to know if your attitude to money has changed significantly in recent decades, both in private and in business terms?
Fred Frank: Well, it’s a sequence. In other words, when I graduated from the Stanford Business School, and I started in Wall Street, my salary was $4,200. And you cannot live in New York City for that amount of money. And I was married at the time and I had a young child, so I took a job teaching at night at the NYU school for business. This gave me a supplement to my salary. Fortunately, at that time I was working at Smith Barney and Company. I progressed pretty quickly. After a year and a half, I could give up my night job. Money at the time was to live on. I mean, I had no extra money for anything but to live on. Our form of entertainment was to go to the movies every two months. Fortunately, I progressed quickly and accumulated money very quickly both from earnings from my salary and annual bonus and investing it successfully.
What it meant to me eventually was to secure a comfortable life for my family. I had two daughters and a wife, and I wanted to make sure that they had a life that was protected if something happened to me. Once I passed that threshold, then what I was very interested in with additional capital was for philanthropy, largely for education and science. I gave a lot of money to the prep school I went to, which is called The Hotchkiss School, in Lakefield, Connecticut, to Yale University, which is my major philanthropy, to Stanford University, and to other philanthropic areas, like the Harvard School of Public Health, and the Johns Hopkins School of Public Health and the Salk Institute. I got a lot of joy, philosophically, from giving money away to what I thought were very worthy causes, mostly associated with educational and scientific institutions that I’d been associated with.
Xecutives.net: You later got very famous. I have seen a lot of articles, even in the New York Times about you. You’ve been seen as a pioneer of venture capital and investment banking. It’s about making long-term investments in promising start-ups and young companies to help them succeed in business. After all, you’ve led quite a few major deals, including the sale of Genentech to Roche in 1990, which I’d like to discuss later. It appears your motivation for these deal-making achievements is almost certainly not just about money. I would imagine that it gives great pleasure to help companies and make them successful, so that they can create value from which all of society also benefits. By helping these companies, you are also helping younger people, especially younger people with good ideas in the biomedical field. This was not only about money, was it?
Fred Frank: Absolutely. When you look at the pharmaceutical and the biotech industries, the people involved, these are individuals with real passion. They devote their life to doing good, trying to improve the quality and longevity of life. And it is a very high-risk endeavor. Many of the people work on their ideas for years, only to find the ideas don’t work – for one reason or another. But they keep at it and they’re very devoted. And one of the interesting things about this industry, if you look at the early companies I worked with, like Genentech, and CETUS, and Chiron, and Genzyme, they’ve all been acquired by Big Pharma companies. But the interesting thing is, once they’ve been acquired, the executives who signed employment contracts initially for two years, they left after those two years and started new companies.
It’s a very interesting way in which we create literally dozens and dozens of new companies from these scientists who are very passionate about finding new and better and safer drugs. I’ve been very blessed by working with many companies from a very early stage. My entry into biotech was started because a very famous scientist and businessman by the name of Alejandro Zaffaroni, who started his career at Syntex, and then left to start a company called ALZA, and then subsequently started six other companies successfully. He called me one day and asked me to come to California, to Berkeley, to visit with a new company called CETUS. And this was in 1977 – maybe 1978, I don’t remember exactly.
I went out there to visit with him and the CEO Dr. Ron Cape said, “Fred, we’d like you to take the firm public. And I asked, “When do you want to go public?” And he said, “By year’s end.” And I said, “Well, that’s not a problem. Which year?” And we laughed and he said, “Well, by this year.” And I said, “Ron, that’s not possible. You’re not ready to be a public company, and it wouldn’t be successful. But the time will come.” So, I continued working with them. And then in 1980 the first biotech company to go public was Genentech. And it was an extraordinary public offering, because they offered one million shares of stock at $35 a share, and the first day the stock traded in the eighties! Now, nothing like that had ever happened before.
Xecutives.net: Why didn’t this happen before?
Fred Frank: First of all, taking a company public that wasn’t profitable was a new event at that time. The fact the offering was so spectacular was unbelievable. That day, after the Genentech public offering, I called CETUS and said, “Now you’re going public.” So that was the second biotech company to go public, and I took them public and they raised $120 million on their IPO, which at the time was the largest public offering ever done. The only other comparable one was the initial public offering of Ford Motor Company. So, history is very interesting. And one of the interesting things about CETUS was, they were working on a drug called IL2 and spent a lot of time and a lot of money, and frankly, at first it didn’t work. I sold the company to Chiron, which was run by two very brilliant scientists. When I sold the company to Chiron, CETUS had a product called PCR (Polymerase Chain Reaction). It allowed rapid replication of DNA, which previously had to be made by hand in a laborious process. And the two heads of Chiron told me it didn’t have any value. And I said, ‘Well, if it doesn’t have any value to you, we’ll keep it.’ So, we took it out of the deal, and I ended up selling it to Roche for $360 million in cash, plus an earn out, so the total was $375 million. And it became one of Roche’s largest products! And PCR revolutionized diagnostics and drug research. Interesting history how this industry works. For a product that supposedly had no value, it became and is still a very valuable tool for the pharmaceutical and biotechnology industry.
Xecutives.net: Now you say, also regarding Genentech, this is value creating, you know, there are still thousands of people working together – at Roche, at Genentech, at Genentech it’s around 15,000 people, at Roche it’s worldwide around 100,000 people, around 12,000 working in Basel/Kaiseraugst. But what is going wrong today, when I am reading newspapers about Credit Suisse, about other banks and companies, sometimes I get the impression, as in monopoly games, that they are playing in the top management? What is going wrong? It’s not about value creation nowadays, what is the problem with this short-sided approach?
Fred Frank: You’re correct. And that’s because there’s tremendous pressure on the managements of these companies by the financial community. By the big fund managers who own substantial amounts of these companies’ stock, but they are investors. And they’re very short term oriented. I mean, it’s really sort of stupid when you think about it. I’ve had a number of conversations about it with companies. They worry about quarterly earnings. How can you worry about quarterly earnings in an industry that takes 8 to 10 years to develop a product? It doesn’t make any sense! But the financial community puts huge pressure on these companies, and in fact, these investors are the owners.
To give you an example that took place two days ago, Walt Disney, which is a phenomenal company, reported their earnings and they did not achieve Wall Street’s expectations. The stock went down very sharply in a very good market. There’s this absolute focus on quarterly earnings, which is really dumb. Unfortunately, the companies can’t do anything about it. There are a few companies who have taken a stand against it. There’s a very famous scientist and biotech company founder by the name of Dr. Stanley Crooke, who had been the head of research at SmithKline. He left and started a company known as IONIS, which has been very successful. He dislikes Wall Street, and Wall Street dislikes him. But Stan doesn’t care. Because he says, “Look. My timeline is long term and theirs is short term. I can’t kowtow to them, so I’m going to run my business the way it should be run. And I’m not going to worry about quarterly earnings. And he’s built a very successful company with a current market value above $5 billion. But there are very few CEOs who are willing to take that stand. They are pressured – not only by their shareholders, but by their boards of directors.
By and large it’s a generalization, but boards often don’t have the courage to do what they should do. They have the same pressures from the financial community. And they give in to it. I often said if I had the chance, I would pass a law that companies should only report financial data once a year, rather than every quarter. I think it would make for better companies, I think it would make for better shareholders, but nobody agrees with me. Years ago, one of our largest pharmaceutical companies was America Home Products. And they used to report monthly. Amazing, right?
Xecutives.net: Absolutely. But that doesn’t mean that these leaders don’t have any other option? An average manager, if I understand you right, is helpless and will probably act in an opportunistic way?
Fred Frank: Yes, because, in fact the shareholders own the company. Depending upon where the shares and shareholders are located, even if they are not listed in various geographies, there are various reporting requirements and corporate law requirements in different countries, The challenge in Europe is these jurisdictional issues complicate company formation and financing. In the U.S., we have broad based corporate and securities law, in general, which assists in new company formation and financing. If you’re the CEO of a pharmaceutical company, or a biotech company, or any company, in the U.S. you’re usually very highly paid compared to the E.U. You don’t want to get fired from your job (laughs). My observation over long years of working with E.U. companies is if you get fired from your job it’s sometimes very hard to get another job anywhere near as good. That’s changing now in the E.U. There is much more forgiveness on such matters here in the U.S. So, in the U.S., not only are you very well paid but you have very substantial stock options, which can end up being worth a great deal of money. You just swallow hard, if investors are being very short term oriented, and do the best you can by placating the big shareholders and meeting their demands as best you can. You try to run the company in an intelligent fashion. But it’s a tradeoff. And as I said, Stanley Crooke is a good example of one who stood up to it and there are other examples.
Xecutives.net: Mr. Frank, you yourself have dealt intensively with value creation. You also gained the respect of Roche, and its two top managers at the time, Dr. Dr. h.c. Henri B. Meier but also Dr. h.c. Fritz Gerber, just to mention two prominent Swiss personalities. What criteria did you use to help startups develop? That’s a big question, a big challenge! What criteria did you use to decide whether to invest in a young company, or a biochemical company, or whatever company – to support a merger, or a sales project? Is there even a certain magic formula that an investor and venture capitalist might apply, or is it also about gut feeling, hunches which cannot be calculated?
Fred Frank: Well, I’ve learned over the years how to evaluate companies. I’m not a scientist by training. And life sciences, biotech, pharma, medical devices, is an industry of science. So, you have to figure out, how do I check the science? There are various ways of doing that. We use applied consultants, for example. But what I’ve found over the years the real basis for successful investing is investing in the management and not in the science. I can give you examples where the early science of the company didn’t work out, but the management were astute enough to figure out they had to take another path, and it became successful. And so, you’re really doing hard work on the character and capability and background of management, and there are two forms of management: There’s scientific groups, and there are management types, but it only works if the “team” works as a whole.
In the early days of biotech, all the companies were run by a founding scientist. And over the years, that changed, where most of these companies now are mainly run by business people experienced in the industry. I think in some ways it was better early on. For example, Genentech. Genentech at the time I helped orchestrate the Roche deal, the CEO was a businessperson by the name of Kirk Raab, who came from Abbott Labs. For an unusual reason, he got fired during the Genentech/Roche deal and the Board promoted a scientist who was the head of research, Arthur Levinson, who did a fabulous job at building the company. Because this is an industry of science. Science is the critical aspect for being successful, but even the best science can be wrecked by inadequate management.
Xecutives.net: Mr. Frank, Henri B. Meier repeatedly points out in connection with his Swiss Future Fund project, a Fund of Fund which would offer pension funds the opportunity to invest in venture capital at a very low risk, that the use of venture capital is not about quick money and that innovative value-creating projects take years. Young companies often have to be accompanied for a long time, and this requires staying power and expertise in selecting the companies to accompany and promote. This explains why HBM BioVentures AG (now HBM Healthcare Investments AG), which he founded after his career at Roche, took its time to be successful on the market and makes shareholders very happy today. This time dimension, however, overwhelms politicians and as well as investors who aim for quick profits. But those managers you talk about, they need venture capital money. And this foundation “Pro Zukunftsfonds Schweiz” – that’s Henri B. Meier’s baby – creates opportunities to invest Swiss savings from collective savings pot in Switzerland, in the job creating real economy at the forefront of technical progress. You know, he says there is a lot of money – about 900 billion francs in this pension fund pot. What has been your experience with regards to the USA? There, venture capital has made USA the technological leader of the world. But I have the impression that here in Switzerland, this concept does not yet work and that even high-ranking politicians do not understand it. What is the problem? Why does it work in the United States? Why doesn’t it work in Switzerland, and what is probably the disadvantage for Switzerland?
Fred Frank: It’s a good and important question. Clearly, the United States is the forefront of venture financing. Then why doesn’t it happen in Europe, which is much more conservative than the United States. The essential cultural difference in the U.S. is an attitude towards risk. When I look at Europe – Switzerland, England, it doesn’t matter – there is some meaningful venture capital, but it’s not prolific as it is in the U.S. The big difference is you don’t have public participation to a very substantial degree in the E.U., and you don’t have the major investment companies like we have here in the United States, that have huge amounts of capital. These large funds, some dedicated to life sciences, provide a very substantial investment base. So, U.S. investors in venture capital know that there is follow on financing for successful venture companies. Take, for example, the universities. In this country, the universities in their endowments – the largest is Harvard, which has an endowment somewhere close to $50 billion. And Yale has the second largest endowment at $36 billion. And then Stanford. These endowments at educational institutions have to invest that money. And so, we have all these major universities with huge amounts of capital to invest. They’re a little more conservative, they don’t invest in biotech, generally. But they do invest in the pharmaceutical industry. In Europe you don’t have these enormous endowments and the same number of large private investment funds. You don’t have this huge platform of capital in educational institutions, in mutual funds, and in all kinds of investment funds. You just don’t have that. And I just don’t think that’s going to change.
Xecutives.net: You are a philosopher, and you have this philosophy degree in your pocket. What do you think, as a philosopher, what’s the reason that you think this doesn’t work, just for instance in Switzerland, also in Germany?
Fred Frank: If you look at the major universities in Switzerland or France or England, they don’t have any endowments of any sort. You don’t have the history of graduates being very philanthropic. You don’t have graduates at these schools giving a lot of money to the university. Take my class of 1954 at Yale, one of the most successful classes in the history of the school. If you take our twenty fifth reunion, then our fiftieth reunion, and sixtieth and seventieth, my class has donated to Yale $600 million! And that does not include some individuals who made contribution to specific scholarships, facilities and other initiatives.
Xecutives.net: That’s a lot of money!
Fred Frank: You have to remember my class wasn’t that big, it was just a thousand. Yale was an all-boys school at the time. It was a thousand boys. But a lot of us have been very successful, and have given a lot of money to the university. That just doesn’t happen in Europe!
Xecutives.net: You do have some very rich people in the United States from Switzerland like Mr. Hansjörg Wyss giving billions of dollars for certain projects, or Henri B. Meier and other entrepreneurs in Switzerland, who finance university chairs and other projects. However, it means a completely different dimension of philanthropy than in the U.S.!?
Fred Frank: Yes, that’s right, there are such people donating money. At Yale, for example, and Harvard, one of their most generous contributors is a Russian oligarch.
Xecutives.net: Mr. Frank, I had an opportunity to do an interview with Professor Heinz Riesenhuber. He is the ex-minister of scientific research under Chancellor Helmut Kohl in Germany. He’s not only a scientist, he’s also a politician, he’s also an entrepreneur, so he brings all those things together. But he said something that shocked me, I was a little bit concerned. He said they asked students around Germany, and something like 67% of the students, they wanted to be public servants. Isn’t this crazy? Or am I wrong? If 67% or 70% of all the students would like to become teachers, or professors, or public servants, something in our system is wrong, isn’t it? When you consider what the USA has been able to achieve with venture capital, but also countries like Israel, it becomes clear that countries like Switzerland need to rethink their security approach that also has an impact on political decisions. What do you think is preventing these other countries, such as Switzerland, from investing part of their savings in the future? Is it about this public servant phenomenon and the fact that most politicians do not have entrepreneurial experience at all?
Fred Frank: Yes, you’re right. It’s a real problem. And it’s going to be a big problem down the road. That doesn’t happen in this country, the United States. The percentage of graduates at university or business schools who go into the nonprofit area is relatively small. And I think the reason they do that is, if you go into the nonprofit side of the business, it’s a much safer life. You get paid a salary and good fringe benefits. You don’t get measured the same way. You’re not at risk of getting fired. Your company’s not going to get acquired, and you won’t be out of a job. It’s a very safe place.
It’s like many people, like at the Hotchkiss School, preparatory for university, for example, where I went to school, you ask the teachers, why did you go into teaching? Well, for a combination of reasons. They get free education for their children. They get nice living conditions. It’s kind of a risk-free kind of a job. And they’re not measured in the same way, so they don’t worry about getting fired. Their kids live a nice life. In a way, if you want to be cynical about it, it’s kind of a copout in life, right, although many of these teachers are truly dedicated to education. Take your example of politicians in Switzerland, but also our current president, that’s a good example too: Joe Biden has never had a real job. He’s only been in government. A lot of decisions he’s making right now are indicative of the fact that he’s never had a real job, I mean just for instance a job in the field of industry. I used to say, if you’re going to teach in the schools and the university, you should have to have spent at least three years in the real world before you can become a teacher in the university. But of course, nobody agrees with me.
Xecutives.net: This question is a little bit pointed now, but what is behind that? Why does it work in another way in the United States, like Mr. Thomas Zurbuchen said? Mr. Zurbuchen is an exceptional Swiss scientist, working at NASA, the National Aeronautics and Space Administration. He’s the chief of the Scientific Mission there. He comes from here, from Switzerland, and he really said that this is true, what Mr. Riesenhuber said. Why is this different? Is it about money? Is the difference that there is a lot of money waiting in front of Harvard and Yale and all those universities? Or is it something in our European mindset that is probably wrong?
Fred Frank: I think it’s the mindset. For example, if you’re a professor at Yale or Harvard or Stanford, and you become well-known in your field, you’re going to get job offers but often of more interest, usually, to these talented academics is advisory roles with companies. They can be well-paid as advisers, but retain their academic posts, their first love. And, they may, through these advisory roles, have the immense personal satisfaction of seeing their science turned into real products over time. So, I look at all the professors I know at Yale, for example, and they all have advisory jobs with biotech and pharma companies. Again, they’re very well paid for that. So, it’s a little different mentality. In Europe you don’t have that. You can be a professor in the United States and make a lot of money, but still continue your academic excellence and discovery laboratory.
Xecutives.net: Mr. Frank, you sold Genentech to Roche in 1990 – you were in contact with Henri B. Meier and Fritz Gerber back at that time – on behalf of the Genentech ownership, a brilliant strategic move by Roche from which the company still benefits enormously today, but also for Genentech, who got a great partner. The company was founded by biochemist Dr. Herbert W. Boyer and investor Robert A. Swanson. With the support of geneticist Dr. Stanley N. Cohen, the company succeeded in developing DNA technologies that were revolutionary at the time; it was able to develop a number of drugs that became blockbusters. Roche is still a very successful company, with its headquarters still in Basel, surrounded by a quite sustainable-thinking family. This is a fine example, Genentech, of collaboration between extremely innovative founders and scientists and venture capital, which was essential in guaranteeing the company’s success. What made Genentech successful? What’s the link between those founders and the money? Can you tell me something about that?
Fred Frank: Let me, perhaps, give you a little of the history, and that will answer your question. So, when Genentech came to me – this is the Chairman and the CEO – they said, “Fred, we have a problem, we don’t know how to solve it and we want your help.” I said, “What’s your problem?” They said, “You know our stock has declined very substantially and it’s down now around $20 a share, and we have a very deep and a very rich pipeline, which we have to fund. If we fund it internally, it’s going to adversely affect our earnings, and if our earnings go down a lot, our stock will go down a lot, and somebody will take us over at exactly the wrong time. So, what do we do?” I said, “Well, let me think about it.”
I came back to them and I had an idea. I said, “I should replicate a deal I just did between Dow Chemical and Marion Labs.” I got Dow Chemical to push their pharmaceutical business into Marion Laboratories, a U.S. public company This created a company called Marion Merrell Dow. And that protected Marion, because Dow Chemical, this big company, as the largest shareholder, with over a 60% ownership interest. My idea for Genentech was, I went to DuPont, and I said, “Look, you have a pharmaceutical business. You ought to push it down into Genentech, who would give you a forty or fifty percent or more ownership, which would be good for you, unlock the value in your pharma business and your ownership and combined pipeline would protect Genentech.” And they hired two famous investment bankers to give them advice. They asked me to come down to their headquarters to visit with them. I went down and the banker from First Boston came to me, and he said, “Fred, we recommended to our client not to do this deal.” I said, “Why did you recommend that?” Saying to myself, you could have told me that on the phone! I didn’t have to take the train all the way to Wilmington to be told you didn’t want to do a deal! I said, “Why did you recommend that to your client?” He told me a bunch of reasons, that didn’t make any sense, including particularly that it might lower Dupont’s price earnings ratio. This I found rather incorrect, as in my view there was absolutely no value in Dupont’s stock price for its pharmaceutical business, given the huge scope of its chemicals and materials businesses.
But it was there, from Wilmington, that I called Roche. And I talked to Henri. And I told him I had an idea that I’d like to share with him. I went over to Basel. And I told him and Fritz Gerber my idea was, they should take Roche USA, and push it into Genentech. They would have a very large ownership and they would then protect Genentech as well as getting value out of it. They liked the idea. Then I went back and forth a couple of times, and I got the deal agreed upon. I went back to Basel to go over the details. When I was going over some of the details, Henri said, “Fred, now that you explain it that way, we can’t do that deal. “I said to myself, “Oh, my God. I thought I had a deal. I don’t have a deal. “
And it was at that meeting that I created what became the Roche-Genentech deal. Then I had to go back to California and explain to Genentech, “There’s been a slight change here.” It was actually a better deal, as it turned out. And really what motivated Henri and Fritz, I think, was they realized that the critical aspect of Genentech was the people. If they acquired the company 100%, like many deals, after a couple of years the people would leave. And then what did they have? So that’s why they agreed to this deal that kept Genentech public. In doing their due diligence I said to Henri and to Fritz, “I’m not going to let you and your research team go to California to visit the company. Here’s what I’m going to do.” We hired a very famous science writer to interview every scientist at Genentech and write up his view of what the science was, what the projects they were working on, the technology, was. I took that to Basel, a very thick report, and I gave it to them. They asked the head of their research to then come to a meeting. They studied this report, and that’s how the deal got done. Until the deal was done, they never went to California. They were very smart, the way they handled it. Because keeping Genentech public, and keeping the management getting rewarded in their own stock, is what motivated all the people who had joined Genentech.
And so, I’ll tell you a funny story. When the deal was done it had to be approved by the shareholders, since Genentech was selling control: 66%. At the meeting with shareholders, which was attended by hundreds of people, including many employees, at the end of the formal part, the chairman asked, “Any questions?” There were a lot of questions. One lady stood up and said, “Mr. Chairman, I want to tell you, I am very opposed to this deal. I don’t like this deal, and I’m going to tell you why.“ And she said, “ I got on the train with Genentech in New York and I expected to take the train all the way with you to California and you’re making me get off in Omaha.” The Chairman, the brilliant venture capitalist Tom Perkins, had no idea how to answer that question. With telepathy I was trying to get to him – ”Hey Tom, it’s a good question, here’s a great answer: “This deal is the assurance we’re going to get to California!”” But he didn’t know how to answer the question. It was a very emotional thing for the employees.
Ownership changed. But Roche was extremely smart in how they handled it, from the beginning to the end.
Xecutives.net: How do you remember–there were two people mainly involved – these were Fritz Gerber and Henri B. Meier. What were the roles between those two managers?
Fred Frank: That’s a very good question. It was very unusual because Fritz Gerber totally depended on Henri from the financial point of view. And what people don’t realize is that during this period Roche was actually having some financial challenges. The reason Roche continued to show growth and earnings is because Henri was investing in public companies with all Roche’s excess cash. Henri was a very astute investor and made a lot of money. He made more money on investments than Roche made in the pharmaceutical sector. Remember, in this industry there’s a classic challenge: You have a very successful product and it’s patented. When the patent expires, the sales go down sixty, seventy, eighty percent, because the generic producers come in and compete against you, mainly on price. Roche was going through one of these periods. They realized, in the case of Genentech, they were getting a very rich and very deep research pipeline and leadership in the biotechnology sector, which none of the pharmaceutical companies were in at the time. Big Pharma all scoffed: “Oh, this, biotech will go away. This is not important. And when these companies fail, we will just hire their best people”. What Big Pharma didn’t realize was first, that the biotech industry was about to explode, and second, that a lot of these brilliant scientists didn’t want to work for big companies.
Xecutives.net: The parties then reached an agreement in principle rather quickly, but the price negotiations between you and Henri B. Meier lasted for almost three months, very interesting negotiations. Thanks to an interesting combination of call/put options an attractive price of about US$ 22 per share could be reached. This because a well-discussed innovation in the finance industry. Can you explain this double option model to me?
Fred Frank: Initially Roche purchased about 10% of Genentech by purchasing new common stock shares directly from the company for consideration of about $495 million. This amount was what all parties thought it would take to finance the development of the Genentech research/product pipeline to commercialization. This purchase was then the public market trading price of Genentech. Simultaneously Roche purchased $500 million of existing common shares from the public shareholders at a significant premium to the market price, giving Roche a 60% ownership of Genentech’s common stock in this combined transaction. The remaining public minority shares (about 40% of the then common stock ownership) were exchanged for a new class of common stock shares that had the following provisions: Roche had the option to purchase those shares which were publicly traded, at any time over a forward five years period, at an initial option price of $36 per share.
The option price escalated on a quarterly basis by $1.86 per quarter ending in five years at $60 per share. I think that the desire of Roche was to leave Genentech a publicly traded company, incentivizing the employees and in keeping with the pride of public ownership the employees all had. However, Roche wanted a structure where they could automatically acquire Genentech under pre-existing terms (which the embedded, escalating option price provided for, without a potential long complicated legal procedure to acquire Genentech). Fritz Gerber and Henri Meier were quite visionary. They understood that the new biological science of Genentech would be enormously valuable to Roche, but at that time acquisition of 100% of the common shares, removing the company from US public markets, might destroy the culture that Roche was trying to optimize, control and shape, by leaving Genentech liberated within defined boundaries. At one point, to the best of my memories of this transaction, Henri made it very clear that the embedded option had two purposes, Roche wanted to be able to automatically acquire Genentech through the option if things went well, but also if things didn’t go well. Very shrewd and visionary by Fritz and Henri.
As the date for the five years expiration of the option embedded in the publicly trading common stock approached, I renegotiated the agreement, extending the final purchase option by four years, and at a terminal price of $85.50 per share. As an inducement to do this transaction, Genentech granted Roche the right to market their products outside the United States and Canada under specific terms:
When Genentech completed phase II clinical trials, Roche could review the data and decide to license the product outside the USA and Canada by reimbursing Genentech for 50% of the R&D costs incurred to date, then paying all the costs to finish the research for the rest of the world approval, and then paying Genentech royalties which started at 15% and escalated to 22%, depending on sales volume. I should note that virtually all the products eventually licensed by Roche greatly exceeded the most optimistic sales forecast.
Xecutives.net: Mr. Frank, today it is assumed that without Roche, Genentech would have run out of steam very soon. It’s difficult to estimate what would have happened to Roche without Genentech, that’s the other thing, then. Roche later on provided large sums to Genentech for research and gave the subsidiary in the US great freedom. I think it’s the same today. What would have happened with Genentech, and what would have happened with Roche without that deal?
Fred Frank: In the case of Genentech, they would’ve have had to explore other options. And what were those options? One is that they could have licensed out their products to big Pharma companies to get some money to do research on those products and the earlier stage pipeline. They could have sold off some of their products for international rights. They could have reduced their research budget substantially. So, they had some alternatives, but none of them were very attractive alternatives. Or, they could have tried to find another partner besides Roche, and I will tell you I think that it would’ve been very difficult to find as good a partner. Yeah, probably I could’ve found another partner for them, but it probably wouldn’t have been as good as the deal I did with Genentech and Roche. Roche had real vision, at a time when biotechnology was very new. Genentech had some alternatives but they weren’t very attractive, and frankly one of the reasons why it worked was Roche had their own challenges at the time and Genentech was the answer to solving their own internal problems – Roche did not have a very rich pipeline at the time. Now as it turned out, as you probably know, the forecasts for the Genentech products in research were quite substantial, but they turned out to be much, much bigger in terms of revenues than anybody had forecast.
Xecutives.net: It’s very hard to forecast revenues in this industry!
Fred Frank: It’s definitely very hard to forecast revenues in this industry. For example, you know the definition of a blockbuster drug? It’s reaching a sales level of a billion dollars or more. And the first blockbuster drug was a product by SmithKline brand named Tagamet. I was asked by the management to give a speech at SmithKline and during my presentation I said to the management team, “Look, take out a piece of paper. I’m going to ask you a question. You’re going to write down your answer. I will grade you according to the right answer, because I have the right answer.” And then I said, “Okay. You’re introducing a product. I want you to forecast what the peak sales would be. What would the highest annual sales be? You don’t have to say what year it will be. What will be the peak sales? Now, I’ve written down the answer. Now the highest guess at SmithKline was $300 million. I had written down $500 million. It turned out it was $1.1 billion. That was the first blockbuster drug.
It’s very hard to forecast, and it goes in both directions. Sometimes it’s bigger than you think, and sometimes it’s not nearly as big as you think. Part of that is because of competition. You know, how long is it before you have competition for your drugs? I’ll go back to Smith Kline. If I had said, “Before you write down your answer, I want you to make the following assumption: A competitive product will be introduced two years after your product is introduced. And its sales will be three times yours. And eighteen months later a second competitive product will be introduced; its sales will be six times yours. Now write down your answer. All those numbers would have been reduced a lot, right? As it turned out, the first competitor turned out to have $3 billion in revenues, and the second competitor, had $6 billion in revenues. The three of them together had $9 billion dollars in sales. Nobody would have forecast it.
Xecutives.net: That is very challenging – for such companies and for the management. It takes a lot of experience to understand all this and it takes people who must think in a creative and entrepreneurial way! There are not many of them around…
Fred Frank: Let me tell you another story in this context. Because I think it’s interesting that what we really deal with is the world of ideas. Many years ago, I called up three heads of Lehman Brothers and said I wanted to have breakfast with them the next day to tell them about an idea I had. They said, “Well, Fred, what’s your idea?” I said, “Come to breakfast, you’ll find out.” At breakfast I said to them, in my judgement one of America’s top fifty companies, for the first time since World War II, can raise fresh equity–can do an equity offering. And it will fundamentally change the company.” And they said, “Fred, what drug company are you talking about?” I said, “I’m not talking about a drug company. I’m talking about Chrysler.” And they said, “What the hell do you know about Chrysler?” So, I said, “Well, I do read.”
Chrysler had gone into near bankruptcy, and had just come out of that crisis based on a U.S. government loan. Given its debts to banks, converted to preferred stock, Chrysler was effectively controlled by the banks. And Chrysler was about to introduce a new concept car called a minivan – they were the first to introduce the minivan. I was convinced this car was going to be a revolution in the automobile industry. I said to my partners,” This is the way Chrysler can raise fresh capital and really make something of the company. Well, it wasn’t that hard to convince my partners. All we had to do was convince Chrysler. We called up the chief financial officer of Chrysler and asked him to come in. He came in every week to New York to visit the banks, since the banks controlled Chrysler. The CFO came in to see me, and I told him my idea. The stock was around $2.75 a share, and I told him, “I’m convinced you can go out and raise $200 million or more.” In those days this was a very large deal. And he was very skeptical. He said, “I want to go and check with our normal investment banker.” Which was Salomon Brothers. They went to Salomon Brothers, and they were very scared about doing a public offering. But they weren’t going to say, no you can’t do it, because then Chrysler might have Lehman Brothers do it. Salomon said to him, “Yes, we think it’s a good idea, but you should only go out and raise a hundred million.”
We filed jointly to raise $100 million. We got on a road show with Lee Iaccoca, who was a very famous CEO at the time and came from Ford. And when we got on the road show, it was so successful that we raised the offering from $100 million to $200 million. From $200 to $300 million. From $300 to $400 million. We actually raised $440 million, and, during this period, the stock went from under $3 to $16 a share. Now normally when you’re raising equity capital it puts pressure on the stock, because stocks don’t go up, they go down, because of dilution. So, the point of my story is that, it’s a realm of ideas. And if you have creative ideas, and they have substance to them, there are many things you can do in the financial community. That’s a great classic example of an idea which actually saved Chrysler. And the minivan became an enormous success.
Xecutives.net: Mr. Frank, You look back at a very successful business life, and are still actively involved in business today. Times changed. Wall Street changed. The banking system changed. What kinds of challenges do you project for the many scientists and companies who have the courage to build an innovative business, and desire success in a very competitive market that can change very quickly? What do you wish for those scientists? What do you wish for younger people with smaller companies that probably don’t obtain money as easily as in the United States? What is your wish? What would you tell them, those younger scientists?
Fred Frank: My advice has always been, follow your passion. Fortunately, in the U.S, there are many opportunities for scientists to get hired by these companies. For example, in the last two years we’ve had over 145 biotech companies go public in the U.S. Well, once they go public and raise a reasonable amount of capital, they’re in a position to hire a lot more people. So virtually all of these companies which have gone public in the last two or three years are hiring young scientists. There’s plenty of opportunity, if your background is good enough. This really is an incredible period because, as you know, stocks have been very strong in the United States in the last three years. There’s been plenty of capital available to start young companies, raise capital. Now in my opinion it’s been perhaps overdone. A lot of these companies have gone public, in my judgement, far too early. They’re unlikely to be successful so we we’re going to have a lot of fallout, sometime in the next two to three years. But right now, it’s very easy to raise capital. And it’s much easier to raise capital for technology companies than for biotech companies. Why? Because in the biotech world, as we were talking about earlier, it takes you 8-10 years to develop a product. But in the technology field, you can develop a product and introduce it in a couple of months. It’s a different timeline.
Xecutives.net: Mr. Frank, Thank you very much for your time spent giving this interview. I wish you and your family health and further success regarding your projects.
© 2021 by Christian Dueblin. All rights reserved. Other publications are only allowed with the explicit permission of the author.
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