Monday, February 6, 2012

Well done, Genomic Health!

When writing about the proposed acquisition of Illumina by Roche I mentioned that I didn't think a $6B acquisition of a hardware maker was the best strategy for Roche to bring their molecular diagnostics business into the DNA sequencing era. (Instead I recommended large-scale, aggressive partnering to grow the molecular diagnostics business.)

In contrast, one company with what I think is EXACTLY the right strategy to advance their molecular diagnostics business into the sequencing era is Genomic Health.

Genomic Health's existing product (Oncotype DX) is a 21-gene PCR test to predict breast cancer recurrence, and a similar product for colon cancer is late stage development. Both of these tests may someday "graduate" to a sequencing basis, if either NGS becomes more economical, or additional value is seen in collecting genomic data beyond the 21 genes of interest. 

But Genomic Health understands the need to augment or match product innovation with platform innovation.

For $20M (or about .03% of the Illumina acquisition price) Genomic Health will be launching a wholly-owned subsidiary devoted to developing sequencing-based tests. This is brilliant on so many levels:

-GHDX kept the founding/leadership team in place, while allowing them to pursue new, more exciting fields. The continuity of the team will be important here, while the new venture won't have to invest in some of the infrastructure already covered by GHDX (such as CLIA certification)

-$20M - while a good-sized investment in R&D - is a more smart-sized play when compared to other NGS-diagnostic players, like Foundation Medicine, which launched with an "A" round of $34M, without even a product strategy. (~15 months after founding, Foundation has just won CLIA certification. This is not an insignificant accomplishment, but still represents the company just now 'reaching the starting line.' )

-For GHDX, the $20M represents about 18 months of operating cash flow. It's a serious investment into (potentially) cannibalizing their own business. If you're a fan of Clayton Christensen and his "Innovator's Dilemma" line of thinking, you'd praise GHDX for being willing to take this initiative, where other former market leaders have treated their existing markets as sacred and protected.

-GHDX is banking on the idea that though their R&D investment will crimp earnings in the short term, equity value akin to that seen in Foundation medicine is likely to result. To illustrate this, imagine if Foundation's $34M seed round valued the company at $50M (post-money, without anything more than a business plan.) For $20M, GHDX has essentially generated $14M in net equity value ($50M enterprise value less $34M cash), and I'd argue that GHDX's venture is worth more than Foundation without spending a dime yet.)

(in fairness, some finance types would argue that with GHDX having a P/E ratio of 126x, reducing operating profit by $10M/yr costs something like $1.26B in foregone equity value, but 1) GHDX's market cap is only $850M, and 2) GHDX is down only 5% since their press release announcing the sequencing initiative.)

-many other companies in GHDX's position might realize the opportunity that NGS diagnostics represent, but instead decide to survey the field of start-ups and trade equity to acquire such products rather than invest in R&D to dilute earnings. GHDX's approach insures that NGS will be a core competency for product development, while still maintaining the option to spin out the subsidiary at any  time. (Continuing to riff on the GHDX echoing some brilliant business strategists like Christensen, I'd say that this represents GHDX's commitment to a Jim Collins 'built to last' culture."

Kudos to GHDX!

-finally, one curiosity: in the press release announcing the initiative, GHDX only once used the word "genomics." (Besides in their corporate name.) Many millions of dollars have been flushed over the last decade by start-ups pursuing genomic solutions. For this reason, I think GHDX has spun their news away from genomics.

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