Five Reasons Illumina Should Fight Roche’s Insulting Low-Ball Bid
Illumina is like the Apple of the genomics business. Tools made by the San Diego company (NASDAQ: ILMN) are revered by genomics researchers around the world just like millions of consumers love their iPhones and iPads. And Illumina holds its dominant position at an enviable moment in history, as we’re heading into a scientific golden age when human genomes will be sequenced for $1,000 or less.
Yet here we are, after more than a month of silly posturing, and Switzerland-based pharma giant Roche is still behaving as if Illumina shareholders are fools who will act on short-term greedy impulse and sell their company for less than it’s worth. The stance is insulting and wrong. If this low-ball takeover deal somehow gets done, it would be bad for Illumina shareholders, bad for the genetic tools industry, bad for science, bad for the San Diego innovation community, and bad for the personalized medicine movement.
This whole Roche/Illumina story burst out into public view on Jan. 25, when Roche said it was making an unsolicited bid to buy Illumina for $44.50 a share, or about $5.7 billion. The press release announcing the move was typically upbeat. Instead of saying the bid was 18 percent higher than the prior day’s closing stock price, Roche spun the story to make the bid look more generous, saying it was 61 percent higher than Illumina’s share price of Dec. 21, the day before rumors leaked that Illumina might be sold. Roche, the world’s largest maker of cancer drugs and a leader in the diagnostics industry, argued that this deal would essentially hasten the arrival of the era of personalized medicine. Roche’s Daniel O’Day, the operating chief of the company’s diagnostics division, said in a statement that Illumina would enable the company to offer a “total solution” which would help researchers discover new biomarkers and pick patients likely to respond to specific drugs.
Roche CEO Severin Schwan described the offer as providing “full and fair value” to Illumina shareholders.
But this offer is nothing close to “full and fair.” It would be more fair to say this action is like kicking a man in the ribs when he’s on the ground. Illumina stock traded as high as $79.40 a share in the last year. The only reason Roche was in position to make such a low-ball offer of $44.50 is because Illumina stock plummeted last fall, after scientific customers stalled purchases in the third quarter because they feared federal research budget cuts. That concern is real, but despite the negative force, Illumina rebounded some in the fourth quarter and now forecasts 4 percent to 11 percent sales growth this year. That’s a strong sign of resilience, when everyone from Life Technologies to Complete Genomics to PacBio and others are trying their best to knock Illumina off its pedestal. During this remarkable stretch of innovation in genomics, Illumina remains the dominant player with a 60 percent share of the next-generation sequencing market. About 90 percent of the world’s DNA sequencing output is now done on Illumina machines, the company said in a Feb. 7 regulatory filing. Forecasting the growth of the market is tricky, but it is expected to grow fast as more scientists get access to genetic analysis machines as they get cheaper.
“The Board believes that Illumina is singularly positioned in a nascent industry, which has the promise and potential to experience extraordinary growth in the years ahead as genetic information becomes broadly applied beyond molecular biology research and into medical diagnostics,” the company said in the filing.
Shareholders aren’t taking the Roche bid very seriously. Roche said that Illumina shareholders had agreed to fork over 102,165 shares at Roche’s desired $44.50 price by its previous deadline of Feb. 24. Given that Illumina has 122 million shares outstanding, Roche still has a lot of persuading to do. But instead of sweetening its offer, Roche extended the deadline to March 23, and started mounting a campaign to win a controlling majority of seats on the Illumina board at this spring’s annual shareholder meeting. Illumina shareholders have continued to bid up the stock, to $51.35 at Friday’s close, which could be a signal that many expect a much higher bid to come.
When I looked over the various company statements and SEC filings on this Roche/Illumina battle late Friday, I tried to come up with a list of “reasons for Illumina to sell” and “reasons to remain independent.” One executive at a genomic computing company—Saeid Akhtari of Cupertino, CA-based NextBio—told me he’s optimistic that a Roche takeover would lead to “rapid development of new technologies offering more efficiency in data production resulting in more research, data and discoveries.” But try as I might to see the advantage of a sale to Roche—even at a price of $60 a share or more—I just don’t think it makes sense. Here are five key reasons why I think Illumina shareholders should stand firm, and reject Roche’s offer.
Reason #1: The price is too low.
JP Morgan analyst Tycho Peterson, in a detailed note to clients on Feb. 9, wrote that Roche’s offer isn’t close to good enough. He has a $70 price target on Illumina shares. “With technology leadership and the potential for open-ended growth, Illumina remains an extremely attractive asset, and we think the stock is likely to command a larger premium,” Peterson wrote.
Peterson’s report has some compelling logic that shows why Illumina would be nuts to sell today. While the concerns about budget constraints at the National Institutes of Health are real—and most scientists who buy Illumina machines depend on NIH funding—that customer base is just where the story begins for Illumina. Future markets are potentially much bigger. If newborns start getting their genomes sequenced in large numbers, and Illumina can capture 10 percent of the addressable market over time, that segment alone is worth $3.5 billion, Peterson wrote. If cancer patients routinely get their full genomes sequenced instead of getting a hodgepodge of specific diagnostic tests, Illumina could pull in $2.5 billion by capturing one-tenth of that available market. If pharmaceutical companies routinely start sequencing genomes of patients in clinical trials to enable more personalized medicine, and Illumina gets that same 10 percent market share, that will be worth $240 million. Taken together, those three markets could add $6 billion in revenues—about six-times more than the amount of revenue Illumina generated in the past year, Peterson said. Illumina has resisted so far, calling the offer “grossly inadequate.”
Bottom line, this is a miserly offer for a company with market leading technology, in a market that is only just now starting to head into adolescence.
Reason #2. Illumina’s operations would likely flounder at Roche.
Sometimes it makes sense for a company to get acquired when the existing management team has burned out, or gotten to a transition point where it needs the expertise or greater resources of an acquirer. That’s not the case with Illumina. CEO Jay Flatley has been on the job since 1999, and guided the company through its rise to pre-eminence. He’s 59 years old, and he’s surrounded by plenty of talent on the board and executive team. Flatley personally holds a 1.7 percent ownership stake in Illumina stock, so you could say he’s motivated to make Illumina succeed.
Compare that with Roche’s record in the genetic analysis tools business. Back in 2007, Roche bought 454 Life Sciences. Founder Jonathan Rothberg promptly left and founded a groundbreaking rival in the DNA sequencing business—Ion Torrent Systems. And what became of 454 once it was part of Roche? Not much. How about NimbleGen Systems, the maker of microarray technologies? Have you much about that system since it was absorbed into the belly of Roche five years ago?
Any company that hopes to integrate genomics into the diagnostic and pharmaceutical business is going to have to have extreme determination, focus, technical chops, stamina, and money. Roche clearly has some very smart people in its organization—it bought South San Francisco-based Genentech in 2009. But coordinating so many people from different disciplines, at any company the size of Roche with 80,000 employees worldwide, is asking for trouble. Creating the future of genomic diagnostics will take the focus, brainpower, and determination of a leaner organization concentrated in one place, like Illumina.
Reason #3: Illumina’s innovation edge would be dulled.
Illumina has been remarkably driven to hold onto its market leadership, and has continued to make its instruments better, faster, and cheaper to fend off rivals like Life Tech, PacBio, and Complete Genomics. Oxford Nanopore was the latest upstart to wow industry analysts a couple weeks ago at a conference, but sure enough, Illumina had the foresight to invest in that company three years ago. People at all those small organizations know their company’s future depends on their efforts, and they have a chance to do something historic. But for people who work at Roche, they know their company will be fine whether some Illumina division thrives or not. There’s no way the average salaried worker can compete with the fire in the belly you’ll find at these startups. Rothberg told me last fall that he couldn’t possibly give out some basic information like his R&D budget, because that would be giving away too much to his competitors. His team is working so feverishly that “this is like 1948 and we’re the Israelis,” he said. I can’t imagine people at a Roche/Illumina division working with that kind of burning intensity to keep their innovative edge.
Reason #4. Anti-trust concerns start becoming real if Roche gets Illumina.
You have to wonder if anti-trust regulators might look askance at a single organization building a dominant position in cancer drugs, diagnostics, and now genomic analysis instruments. My guess is that this would probably pass muster with regulators, because no company has a true monopoly on any of these industries. But it’s conceivable that a company the size of Roche could use unfair “bundling” techniques that would hurt DNA sequencing competitors and consumers.
Reason #5. The innovation community would be harmed.
This is the one argument you rarely hear, but it needs to be raised. Illumina is an anchor of the San Diego biotech hub, and one of the great stories of American technological innovation of the past decade. It employs 2,200 people in positions that provide work with meaning, good wages, good benefits, and relative stability in a volatile industry. Roche said some things in January about how it wants to establish an “Applied Science” division in San Diego, but it wouldn’t be the same as Illumina. If this deal goes through, it would weaken the San Diego biotech community, and American competitiveness.
For these reasons, I’m hopeful that Illumina and its shareholders will weather this storm. I’m willing to bet that five years from now, when sequencing is part of mainstream medicine, people will chuckle over memories that Roche once tried to pull a fast one, and buy Illumina on the cheap.