Sunday, January 29, 2012

Illumina - Roche

I am having a hard time rationalizing the Roche bid for Illumina. Not that Illumina isn't a great company (it is) or that Roche isn't a great company (it is too), but the Roche press release announcing the hostile merger rationalized the potential Illumina acquisition as to "enable the discovery of complex new biomarkers improving drug discovery and the selection of patients most likely to respond to a targeted treatment with high clinical relevance. In addition, by building on Illumina’s capabilities Roche will be able to use its scale, global distribution and diagnostic test development expertise to develop new diagnostic tests that serve patients and customers even more effectively.”

I read that as "we (Roche) want to transform our diagnostic presence in "old" technologies (like IHC assays) into way-cool sequencing-based molecular diagnostics, and the best way to do that is to buy a hardware company that is just now being usurped by LIFE's Ion Torrent sequencing solution."

This doesn't make sense to me, as Roche could probably get such biomarker & diagnostic discovery expertise for 1% of the price of acquiring Illumina by striking 100 x $600k partnerships with biomarker/diagnostic focused companies.

One other problem: Illumina doesn't do any biomarker/molecular diagnostic  discovery/development. 

As of Ilumina's July SEC filings, 94% of Illumina's revenue is derived from hardware or consumable sales. The other 6% is service revenue, largely revenue from companies like 23andMe that contract with Illumina to perform very standard genotyping on their behalf.

(Incidentally, molecular diagnostics and DNA sequencing represents ~4% of Roche's business, by revenue.)

Illumina may be the best in the world at building, selling, and servicing genome sequencers (though LIFE's Ion Torrent technology may have just leapt ahead. For now.) However, because Illumina doesn't compete with their customers, they don't do biomarker discovery, development of diagnostic tests, or performance of FDA-approved clinical diagnostics. 

(I believe that Illumina has gotten their hardware platform certified by the FDA, facilitating the development of clinical diagnostics by their customers, but no specific tests approved by Illumina or their customers.)

I could understand Roche's pursuit of Illumina if they were looking to augment or replace their 454 sequencer business. 454's pyrosequencing platform is widely perceived to be past peak and far behind Illumina and LIFE's sequencing platforms (and also behind Complete Genomics and PacBio's platforms in terms of value). However, hardware is a low-margin business compared to Roche's drug & diagnostic business, and Illumina's sales growth has run full speed into a wall, as of the most recent quarter, falling about 20% short of analyst revenue expectations.

Roche has offered $44.50/share for Illumina, but the market has already upped ILMN's stock to $51, valuing Illumina at a crazy level:

66x P/E
6X price/revenue
2.5X PEG ratio
19X enterprise value/EBITDA

So Roche is willing to pay a high price to grab ILMN. If it is not for biomarker/diagnostic discovery expertise, why in the world is Roche interested? Here's my guesses:

-Roche's 454 technology is cooked, and it is better to spend $6B to buy $1B in new revenue to "pave over" the future financial hole that the 454 business represents. But Illumina's sequencing technology  while an improvement over 454, is still behind the leader, Ion Torrent (LIFE).

-Roche is "skating to where the puck is going to be" w/r/t NEXT next-generation sequencing (Nngs), as they (Roche) like ILMN's positioning for Nngs (Likely nanopore sequencing.) Possible, but not likely, since as a hostile offeror, Roche hasn't had a look at ILMN's R&D. Plus, Roche cut their own nano pore technology deal last fall

-Roche already has biomarker/diagnostics discovery talent & expertise (especially from the old Genentech), and they really just need hardware and sequencing talent. Makes sense, except there's no reason to spend $6B to get access to hardware, especially when the technology is changing so fast. Roche could buy 100 sequencers for 2% of the acquisition price, or just partner with a sequencing provider like BGI.

Or, most likely: following the earnings & revenue stumble by ILMN in the 3Q, in spite of the resulting valuations, Roche is trying to buy low on the apparently mis-priced ILMN asset.

This would make sense to me, and I think it would be acceptable rationale for a press release, but Roche has not taken that tone. Perhaps this is to dissuade other potential suitors, like GE. (GE might say when considering an Illumina bid "nice asset, but we don't have any therapeutic or diagnostic expertise.")

If not Roche looking to get a deal on Illumina, I can't buy into other rationale, unless I am missing something. If I am, please let me know in the comments section.