Why Genentech will say 'yes' to Roche

NEW YORK (Fortune) -- As Genentech's board weighs Monday's $43.7 billion merger proposal from Roche, the South San Francisco biotech has one overarching reason to fall deeper into the arms of the Swiss drug maker that already owns most of its stock: Genentech's "biological clock" is ticking.

Market and regulatory forces are driving biotech and Big Pharma closer together. For 30 years the biotech industry has led a charmed life. Companies that develop biologic remedies such as Genentech (DNA), Amgen (AMGN, Fortune 500), Gilead Sciences (GILD) and Genzyme (GENZ) have been free to flourish without many of the regulatory and competitive pressures that giant pharmaceutical companies face. That relative freedom allowed global biotech sales to grow 12.5 percent (to $75 billion last year), compared to a 6.4 percent rate of sales growth for Big Pharma drugs.

But this magical existence is likely to come to an end - and soon. Hooking up with a big drug company increasingly looks like the sensible thing to do. "There are going to be heavier burdens placed on biotech over the next five or so years" says Murray Aitken, a healthcare market analyst with IMS Health. Aitken believes that as patients spend more on biotech remedies, doctors and insurers will scrutinize prices more closely.

At the same time, biotechs are likely to experience greater competition in disease areas like cancer from big drug companies that have bought smaller biotechs or developed alliances with them. Meanwhile, the regulatory picture for biotechs is radically changing. As drugs from the first wave of biotech approvals two decades ago are approaching patent expiration, patients, doctors and insurers are demanding inexpensive alternatives to biotech drugs. Congress and the Food and Drug Administration are under pressure to fashion a new regulatory pathway for federal review and approval of generic biotech drugs, or "biosimilars."

In June 2007, the Senate health committee passed the "Biologics Price Competition and Innovation Act," a law that seeks to allow biosimilars into the marketplace. The proposal is still wending its way through Congress, but it is seen as inevitable. "Sure, companies would have to adjust," says Sandi Dennis, an attorney for a biotech industry trade group. "But a new framework would bring predictability, which is useful."

For its part, Genentech is in a good position relative to its peers. The company's sales grew 19 percent to $8.5 billion in 2007, thanks to its three flagship cancer medicines Avastin, Herceptin and Rituxan. Genentech also has a brimming pipeline of future medicines in development.

Even so, when deciding whether to sell Roche the 44% portion of Genentech it doesn't already own, the biotech is likely to consider Roche's experience selling in mature markets, as well as the Swiss pharma's regulatory acumen.

Genentech's board will likely conclude that it's time to settle down - because the biotech's idyllic youth is coming to a close.