Genzyme drugs debacle may hurt company for years

Henri Termeer, CEO of Genzyme, pauses to consider a question during a Reuters Biotechnology Summit in Boston, February 22, 2006.

BOSTON (Reuters) - The manufacturing debacle unfolding at Genzyme Corp is not just hurting its bottom line: it threatens to dent the company's reputation for years to come.

Genzyme, which is one of the world's biggest and most respected biotech companies, halted production in June at its Allston Landing plant in Boston due to contamination caused by a virus.

The shut-down led to shortages of two of its biggest drugs: Cerezyme for Gaucher disease and Fabrazyme for Fabry disease, two rare genetic disorders. The drugs generated $1.7 billion of sales in 2008.

Temporary disruptions to treatment can be tolerated by most patients, but over time both diseases can cause life-threatening organ damage. Genzyme is the world's leading supplier of treatment.

"We have let down the patient community," said Genzyme Executive Vice President David Meeker. "The ultimate loss of credibility for a company is lack of supply."

Investors are disenchanted. Earlier this month Genzyme's shares were trading at their lowest in five years.

"There's certainly a lot of mistrust right now," said Scott Harrison, an analyst at Argent Capital, which has $700 million under management but sold its stock in Genzyme in April after the manufacturing problems started to emerge.

"They have just been making one excuse after another."

Investor concern over the manufacturing crisis coincides with an increased threat of competition to the company's main products from Shire Plc and Protalix BioTherapeutics Inc, and frustration among investors over its accounting methods.

In May, Genzyme said that in response to investor feedback it would reduce the number of costs it describes as one-time items in its earnings statements.

Previously, the company had predicted earnings excluding items of $7.00 in 2011. Under the new method of accounting that figure is expected to be $5.84.

"In the past it wasn't an apples to apples comparison," said Argent's Harrison. "When comparing Genzyme to other companies who did things differently, it seemed Genzyme was cheaper than it appeared."

ACQUISITION FEVER?

Genzyme has sanitized and restarted its plant and expects to be able to fully supply patients by early next year. But that may not be the end of its problems.

"The question is: 'how much have they shot themselves in the foot?'" said Bill Tanner, an analyst at Lazard Capital Markets.

Many analysts believe that once the company's manufacturing problem is resolved, sales and earnings will pick up. Of 20 analysts surveyed by Thomson Reuters, 14 have a "buy" or "outperform" rating on the stock.

Others are more skeptical.

For Ralph Whitworth, principal at Relational Investors, which owns 6.8 million shares and is one of Genzyme's largest shareholders, the manufacturing meltdown is symptomatic of a broader malaise at the company.

"They have been overpaying for acquisitions and underinvesting in their manufacturing processes," he said. "Instead of taking care of their current portfolio they are more interested in some new drug."

Over the past 16 years, Genzyme has made nearly 30 acquisitions, spending $6 billion in the process.

The acquisitions were made, in part, to lessen the company's dependence on Cerezyme, which generated sales of $1.2 billion in 2008.

That is roughly a quarter of the company's total 2008 revenue of $4.6 billion. In 2000, Cerezyme accounted for 71 percent of sales.

Now, the company has a presence in oncology, kidney disease, osteoarthritis, cardiovascular and metabolic disease and organ transplantation.

Genzyme has invested substantially in plants around the world, but it will be two years before it has enough capacity to survive another manufacturing melt-down at Allston.

Diversification is important, said Whitworth, who is known as an activist investor, but he says Genzyme has gone overboard and maintains the company's compensation structure is to blame -- something Genzyme's Meeker denies.

Genzyme's executives are compensated based on revenue and earnings growth. Acquisitions are a quick way to increase revenue, and analysts have long complained that Genzyme is apt to pay too much for them.

"Right now they can go out and buy their own bonuses," Whitworth said. "It's like what the banking industry did: deals that give them near-term benefits but long-term risk."

In an interview earlier this year, Genzyme's chief executive, Henri Termeer, acknowledged the danger of making too many acquisitions, and said Genzyme is careful to make sure it doesn't bite off more than it can chew.

"You have to be careful not to get seduced into situations where you acquire more than you can absorb," he said. "When you take on a program you take on a lot of obligations."

Whitworth, who says his firm has been talking at length with Genzyme, said the Cambridge, Massachusetts-based company is beginning to make changes.

The company is trying to improve its plant to make it less likely that a virus can enter the system. And it is planning changes at management level.

"They have much to be proud of," said Whitworth, "But it will take at least a few years of sound capital allocation and superior communications for the company to regain the confidence and esteem of the marketplace."

(Editing by Steve Orlofsky)