Genomes-R-Us: Is BGI now Complete?

9/25/12

The sad endgame in the acquisition of Complete Genomics (NASDAQ: GNOM) came last week: having failed to create a sustainable business, CGI was put up for sale in June of this year, culminating in a takeover by sequencing powerhouse BGI for $117.6 million in cash plus $30 million in bridge financing.

Behind that headline is a fascinating story: a U.S. company losing despite being right about its market; a Chinese company succeeding by vigorous price competition and then buying its rival; and a glimpse of the future of genomics-driven medicine.

On the surface, the sale of Complete Genomics looks like a case of overreach by the company’s investors and management coupled with poor execution. Complete, founded in 2005, had early on identified a superior business model for the coming era of cheap and frequent sequencing: take the sequencing activity and much of the interpretation out of the hands of hospitals and other healthcare providers and instead provide it on an outsource basis—both the sequence data itself as well as the all-important interpretation. For an apt analogy, think of Google’s core search business: why own a server farm when what you need are the search results?

I strongly remember meeting the late, visionary venture capitalist Alex Barkas of Prospect Ventures at the JP Morgan Healthcare Conference in early 2008 and hearing him forecast a glorious future for Complete Genomics. Even though the market was at that time buzzing about the next high-speed sequencing technology play, Pacific Biosciences (NASDAQ: PACB), Barkas was supremely confident that CGI’s innovative business model would rule the day. That vision, driven by Complete Genomics CEO Cliff Reid as well as by Barkas and other investors, brought in VC and public investment of more than $250 million. The company went public at $9 a share and sold for as much as $17 a share before plummeting into the $2 a share range, where PacBio also now languishes. BGI’s purchase price correlates to $3.15 a share.

There were some momentary triumphs along the way, including technical breakthroughs, such as increasing the accuracy of sequencing. But, as Technology Review put it, “Though a 2011 paper published in Nature Biotechnology found that Complete Genomics produced more accurate DNA data than competitors, superior accuracy never translated into financial success.” CGI scored some small commercial successes along the way, such as landing the Mayo Clinic as a client in February of this year. Along the way, CGI was able to drop the price of a full human genome sequence to $4,200 in 2011, down from $12,000 in 2010.

But CGI’s revenues and, presumably, its margins dropped along with the price and the company never made up the difference on volume. Even worse, the company lagged in processing the genomes it had promised to sequence. The backlog in the end numbered in the hundreds of genomes. And even if CGI had been able to keep up with the influx of genomes it had, the customers did not come in sufficient numbers to create growth. A CGI business development executive told me in February that the only thing that would drive a higher stock price would be when the company proved its value and thereby showed big revenue gains. That executive has since left the company and, far from being able to build a sustainable business around this model, CGI first had to downsize and then had to be sold. And the buyer, in what must seem to insiders like a bitter irony, is a former competitor, the U.S. subsidiary of Shenzhen, China-based BGI.

BGI is not just any competitor. In fact, BGI had arguably represented the biggest obstacle standing in the way of Complete’s success. As CGI tried to increase its market share by cutting prices, BGI responded by cutting them still further. BGI, using sequencers from Illumina, had a lower cost of capital due to the patience and strategic orientation of its investors. Like Amazon.com, the company and its investors focused not so much on quarterly earnings statements, but rather on BGI’s market share. They chose to operate BGI at what must have been a loss for several years and succeeded at driving CGI to the auction block. (BGI was founded in 1999, and in 2010 it received $1.5 billion in funding from the China Development Bank to expand its operations, according to Isaac Ro of Goldman Sachs.) BGI apparently succeeded in a big way. In January, 2011, Nature estimated that of the 30,000 human genomes that would be sequenced that year, BGI would be responsible for 10,000 to 20,000 of them. The lower prices were good for customers but bad for competitors (bye, bye, CGI).

A transition waiting to happen

So if BGI emerged triumphant from the bruising price war, why did it buy its former rival? Several reasons, all of them interesting. Like every other player in the commercial world of genomic sequencing and analysis, BGI is on a journey from research to clinical applications. BGI hopes that the market finally (finally) expands once sequencing becomes a routine clinical activity ordered by physicians and reimbursed by insurance companies. In other words, like CGI was, BGI is eagerly preparing for sequencing to become part of routine disease diagnosis and determination of therapy.

The transition to clinical adoption of sequencing has been “just about to happen” for the last five or six years. If and when it does (and I am still betting that it will), BGI needed to be prepared. It was facing several obstacles, all of which can be overcome or at least reduced with the pickup of CGI:

Reduce or eliminate dependence on Illumina: Illumina is increasing and speeding up its service offerings. BGI had become dependent on sequencers from Illumina, the market leader in sequencer sales with over 60 percent share, which had provided most of its 100-plus machines. (According to a research note published by Wall Street analyst Peter Lawson of Mizuho on Monday, Sep. 24, Illumina’s market share has actually reached 66 percent.) Now that Illumina is moving into sequencing-as-a-service in a much bigger way, it will be more of a competitor to BGI. Thus, owning CGI and its proprietary sequencing technology (and different reagent suppliers) will give BGI an advantage.

Improve turnaround time: Shipping samples across the Pacific was not an efficient way for BGI to deliver data to customers in the U.S. market. Research institutes might have put up with it but clinicians will not. By buying Complete Genomics and its California-based sequencing “factory,” BGI is moving closer to its customers.

Add customers and capacity: BGI picks up not just CGI’s customers (like the Mayo Clinic) but also its 25 or so sequencers. Isaac Ro of Goldman Sachs last week told GenomeWeb that the deal accelerates BGI’s expansion into the U.S. and gives it “an immediate infrastructure and service offering that will complement the facilities in China.” Former CGI developer Zhanzhi Hu told me in a phone interview that “If CGI has a healthy factory, it could crank out 1000 genomes a month—a not insignificant number.” BGI will need that capacity and more. A reliable industry source told me that the Mayo Clinic deal is expected to require sequencing of 200,000 human genomes over the next five years. Too bad for CGI that they could not hang on long enough to do all that sequencing!

Become a clinical laboratory: This is perhaps the most important reason. CGI applied in July to the U.S. government to attain status as a CLIA lab. The decision, expected to be positive, should come in late 2012 or early 2013. The decision to buy CGI echoes the recent $50 million acquisition of former personal genomics company Navigenics by the second-largest sequencing manufacturer Life Technologies (NASDAQ LIFE). In its acquisition announcement, LifeTech declared that it will shut down the Navigenics consumer business while maintaining its CLIA lab. (Illumina has had a CLIA lab since 2009).

Growing up and being clinical

If sequencing goes clinical, BGI will be able to play sooner and better based on its pickup of CGI. Although BGI already has a U.S. sales presence, it has no way of serving clinical customers in the United States. If the CLIA lab designation comes through, then BGI will be able to sell clinical sequencing right away. One of the immediate drivers of the deal may have been Illumina’s predicted hesitancy (according to my industry sources) to sell clinical-rated instruments to BGI rather than research-only instruments once Illumina receives its expected 510(k) clearance from FDA.

There is also a cultural aspect. BGI has built a stellar reputation as a provider of genome sequence data. But it is not a U.S. company. By keeping CGI up and running as a U.S. subsidiary, BGI can—assuming that the deal goes through—sell its services more easily as it competes with U.S. players like Illumina and LifeTech.

The race for improved sequencing hardware will not slow down. But as this acquisition shows, the more interesting battlefield, at least for the healthcare field, is in the interpretation of clinically obtained genomic data. The same week that CGI was acquired, Foundation Medicine secured a $42.5 million financing (funded in part by major clinical diagnostics players Roche and Laboratory Corporation of America) to pursue forward-looking genomic medicine in oncology; and the University of Texas M.D. Anderson Cancer Center announced an up to $3 billion “Moon Shots” initiative to significantly improve cancer care outcomes, in part by paying closer attention to genomic data.

Clinical sequencing is coming, first in diagnosing especially pediatric diseases of unknown origin and in oncology, then later in gastrointestinal disease (gut microbes…), and perhaps even, much later, in population screening. It just (barely) did not arrive in time to make a success of Complete Genomics. I suspect that BGI and its patient investors will have a better chance.

Steve Dickman is a former venture capitalist and the CEO of boutique consulting firm CBT Advisors as well as the author of the blog Boston Biotech Watch. Follow @

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  • http://twitter.com/Nanostring Nanostring Founder

    Author:
    “Complete, founded in 2005, had early on identified a superior business model ”

    Could you, please, elaborate what you mean by that? There is nothing new or unique, and certainly nothing superior in the service business model. There had always been service shops in sequencing but none have prospered exceptionally. Perhaps the best early example was Lynx Therapeutics – the mother of all so called “next-gen” platforms, that came from Sydney Brenner’s lab – which went nowhere, among many others.

    This has always been and still is an instrument business. If we look at your article, you say that BGI is doing great, sequencing 10-20K enomes last year. OK great, but at $4K per pop, that’s $40-80M in revenue. Compare that with ILMN, which had close to a $1B in sales and you see that we are talking different orders of magnitude.

    CGI’s story is much simpler, indeed: a CEO who was an industry outsider (came from online video background) and who was (1) talking-up misleading nonsense about millions and gazillions of genomes sequenced,(2) enjoyed the support of the VCs on the Board (particularly his buddy Chad Waite) (3) earned tons of money for himself while the Board was watching and protecting him, while (4) the investing public (incl. pensions funds, etc.) lost tens of million$$.

    Simple story of fleecing the public market, using a crony Board as cover, same story you see everywhere, sadly…

    • Steve Dickman

      I see the future of sequencing not in the boxes (commodifying…) but in the data. IBM would have died as Microsoft rose had IBM’s main business been in PCs. And now look at Compaq/HP and Dell. They ARE dying. The success of Apple, which made itself about software and sales, speaks for itself. ILMN apparently agrees with me, given its recent move into offering sequencing services as well as boxes.

  • http://twitter.com/Nanostring Nanostring Founder

    Author:
    “Complete, founded in 2005, had early on identified a superior business model ”
    Could you, please, elaborate what you mean by that? There is nothing new or unique, and certainly nothing superior in the service business model. There had always been service shops in sequencing but none have prospered exceptionally. Perhaps the best early example was Lynx Therapeutics – the mother of all so called “next-gen” platforms, that came from Sydney Brenner’s lab – which went nowhere, among many others.
    This has always been and still is an instrument business. If we look at your article, you say that BGI is doing great, sequencing 10-20K genomes last year. OK great, but at $4K per pop, that’s $40-80M in revenue. Compare that with ILMN, which had close to a $1B in sales and you see that we are talking different orders of magnitude.
    CGI’s story is much simpler, indeed: a CEO who was an industry outsider (came from online video background) and who was (1) talking-up misleading nonsense about millions and gazillions of genomes sequenced,(2) enjoyed the support of the VCs on the Board (particularly his buddy Chad Waite) (3) earned tons of money for himself while the Board was watching and protecting him, while (4) the investing public (incl. pensions funds, etc.) lost tens of million$$.
    Simple story of fleecing the public market, using a crony Board as cover, same story you see everywhere, sadly…

  • Crooks Inc

    This is just the story of a totally incompetent, borderline fraudulent CEO in Cliff Reid. Why was he put in charge? Why was he LEFT in charge when it was clear he was unable to execute? Those claims of a million genomes — where are they? Any correct decisions made? Nope. Last I read Complete Genomics had a BACKLOG of genomes to sequence, exemplifying absolutely pathetic planning.

    I’m surprised there’s no lawsuit filed…yet.

    • http://twitter.com/Nanostring Nanostring Founder

      Well, you shouldn’t be surprised anymore. Two lawsuits filed yesterday:
      http://www.genomeweb.com/sequencing/shareholder-lawsuits-seek-stop-bgis-buy-complete-genomics

      I should say that Drmanac is a sequencing legend, and the technology was most likely very good. This is just truly horrible job done on shareholders (again, including pension funds, VC’s own LPs, etc.) by a crony Board/CEO…

      From one of the lawsuits:”certain of the Company’s named executive officers and board members
      will receive significant compensation in the form of severance payments
      and accelerated vesting of stock options and restricted stock – benefits
      that are not otherwise available to” shareholders” … and that’s after years of sucking down fat salaries and bonuses. I think Reid’s 2010 compensation was $1.8Mln and they never disclosed 2011…

      Like I said, your regular fleecing of the public investor by a crony Board and CEO.

    • Kenneth Rubenstein

      Reid is fine. The problem is part of a typically premature Silicon Valley VC mini-feeding frenzy. Occasionally they strike oil. More usually, they come up dry. Someday, whole genome sequencing may prove its value, but that’s a long ways off. Sequencing instrumentation is very valuable for basic research, but that’s about it for now.

  • Kenneth Rubenstein

    When it comes to genomics, personalized medicine, and sequencing, efforts at translation of basic research are laughingly premature. Only a decade ago, our view of genes, the genome, and its relation to biology and medicine were hopelessly naive. Today we’ve uncovered a vast abyss full of unknowns that will likely take decades to unravel via basic research. Furthermore, DNA is only one piece of a much larger systems biology puzzle. It’s really ridiculously early days for any sustainable personal genome effort.