The M&A game….

…..featuring Illumina + Roche again and an addendum to my post last week about the Affymetrix-eBioscience non-deal. What do these 2 deals have in common?

Luke Timmerman @ Xconomy has a good piece this week with 5 reasons why the Roche + Illumina deal isn't right for Illumina. I shared reason #6 in the comments:

• "…..because the touted “total solution” provided by a Roche + Illumina combination is a fairy tale. Illumina sells equipment. Roche sells drugs and diagnostics. What tiny bit of equipment that Roche sells (454) hasn’t done well. I don’t see how selling Illumina equipment makes Roche’s drug or diagnostics businesses any better. What “total solution” becomes enabled by the combo that isn’t possible by Roche just buying a roomful of Illumina (or someone else’s) sequencers?" 

What the ILMN-Roche and AFFX-eBiosciences deal have in common is that both deals are now an exercise in game theory. Consider ILMN's options:

1. Accept Roche's bid. (notgonnahappen. Roche's offer is ~$6 below the current price) 
2. Adjust the terms: wrestle for a higher bid from Roche or find another bidder to up the price. 
3. No deal. Win a proxy fight by making the stand-alone scenario more real and financially attractive. 

Likewise, consider eBioscience's options:

1. Accept AFFX's likely revised downward terms, though still rich, in order to allow AFFX to win debt financing of the acquisition. 
2. Adjust the terms by selling to another suitor, likely at a lower price than AFFX's rich offer. 
3. No deal. No liquidity for investors. 

Timmerman argues Illumina shareholders should vote to remain independent for largely qualitative reasons. Unfortunately, I think the decision to be made by shareholders is much more cold and quantitative: what's the better risk-adjusted net present value?

1. Roche's $44.50/share bid, (again, notgonnahappen.) 
2. a sweetened bid, or 
3. the capital gains in future years from selling ILMN shares after the company stock re-appreciates. 

Putting some #'s to #3. Using round figures, ILMN is at $50/share, and had a previous high of $80/share. Holding ILMN stock for 2 years to see $30 in appreciation would require an annual return to equity holders of 26.5% - a not unreasonable scenario, particularly in such a growing industry. The problem is, the $30 gain offered in the future (over two years) can be made a lot less relevant with a sweetened bid 'now' by Roche.

What if Roche offered an additional $2B, which would raise the ILMN offer to $60/share, or about a third of the 2-year gain upfront? This might be hard for ILMN shareholders to turn down, especially if the offer is cash-heavy.

To me, and likely to both ILMN shareholders and Roche management, the outcome is determined largely by your appraisal of ILMN's NGS technology. If you think ILMN is in danger of being passed by Ion Torrent or Oxford Nanopore, you take a sweetened offer from Roche. If you think ILMN has the tech to stay on top, you probably hold your shares (or, if Roche, increase your bid.)

All of this says to me that we should be on the watch for a public unveiling of ILMN's future NGS tech, or their roadmap as such. (Via a press conference or an analyst day, or the like.) ILMN is currently touting NGS prices of ~$5,000 per genome. If they can demonstrate a technology (or path) that drives this number down into ONP's ballpark (~$1,000), expect ILMN to stay independent. If not, ILMN will take Roche's best offer.

Roche has already played their role in this game, as they played the "you know you're not the only fish in the sea" card - even though the whole world knows that there isn't an equivalent alternative NGS investment available. (Unless you think PACB or GNOM make for good back-up plans.) I interpret this as Roche saying that they're open to paying a bit more for ILMN - otherwise, they'd play either the "take it or leave it" card.

Nearly six weeks have passed since Roche's hostile bid and yet Illumina hasn't shown off any reason for shareholders to expect ILMN stock to pop as an independent company. Be on the lookout for either a sweetened Roche bid or a big ILMN tech exposé.


While ILMN is looking for paths to increased valuation, eBioscience must be looking for how to avoid too much decrease in valuation. It looks like AFFX can't do the current $330M deal, as lenders are pulling their financing. They could seek another bidder, but presumably they held an auction before accepting AFFX's bid, and know the possible range of offers. At 4.7X trailing revenue, the AFFX offer is very rich.

As a mostly-commodity provider, eBioscience probably still wants to get a deal done, even if AFFX can't honor the proposed terms. (btw: there are differing reports on whether AFFX's offer is all-cash or 50/50 cash/equity.) Would eBioscience rather take a tweaked deal from AFFX at say 90% of the value, or - as they are a growing company - sell a year or two later to someone else at a reduced multiple? (say $80m in 2012 revenue x a 3.75X multiple (=$300M.)) Chances are, this offer from AFFX represents the best and most lucrative chance for liquidity for eBioscience shareholders that they are going to see for a while.

The best outcome here for eBiosciences is to negotiate a sale at a point between their best alternative purchasers' price and the $330M, or to alter some deal terms to slightly reduce the value of consideration from AFFX. eBioscience could keep the same headline number, but accept a mix heavier on equity than cash, for example. Or, eBioscience shareholders could provide the debt financing themselves, in the form of an earn out or milestone payment from AFFX.

Unlike ILMN, I don't think that eBiosciences has to worry that their suitor will have a change of heart. If the financing gap can be bridged, the deal will happen. At this point, it seems to be a matter of how much less lucrative terms eBioscience is willing to accept and whether this figure works for AFFX's bankers.

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
18X EV/OCF


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.