Apr. 12, 2012
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Roche Ratchets up the Pressure on Illumina

If there is an axiom to describe F. Hoffman-La Roche, it is that what Roche wants, it gets. The Swiss-based multinational pharmaceutical company bought a majority stake in Genentech in 1990 and decided in 2008 that they wanted the rest of the company. In July 2008, Roche offered $43.7 billion for the 44% of Genentech that it did not already own. Roche went hostile in January of 2009, cutting its bid to $42.5 billion, but eventually relented and paid $46.8 billion in March 2009. The final price represented a 10% premium over the January bid. Genentech investors initially balked at the takeover, but Roche held strong in its commitment. Eventually, they sweetened the deal for Genentech investors, but one way or another Roche was not going to let go until it had full control of its target. Now the pharmaceutical giant has set its sights on the San Diego-based sequencing powerhouse, Illumina. Considering the scale of the offer, it appears now to be a matter of when, not if, a deal will get done.

Roche attempted a friendly takeover of Illumina in late 2011, offering $40/share or $4.9 billion for a company valued at just under $4 billion before Roche's advances became public. In January 2012 Roche increased their bid for the sequencing company to $44.50/share or $5.4 billion. After only 0.1% of Illumina shares were tendered at this price, Roche finally increased its bid at the end of March to $51/share or $6.2 billion, a significant 14.6% premium over the previous offer. Despite these aggressive overtures, however, Illumina's management and board have disparaged the offers as grossly undervaluing Illumina and its future prospects. This position is not entirely unreasonable, considering the fact that Illumina supported a market capitalization of over $8 billion for much of 2011. On the other hand, despite their claims about the value of the company to shareholders, Illumina's management and board of directors must also have their own interests in mind.

A valid reason for Illumina's decline from its former, lofty market capitalization is the uncertainty of its prospects in an increasingly crowded field of competitors; this may be as good as it gets for Illumina. The current offer will reach an inflection point on April 18 at Illumina's annual meeting, where Roche will take its case directly to shareholders.

Roche may succeed there. At the end of 2011, only seven major institutional shareholders controlled more than 50% of Illumina shares, and Roche has reportedly worked with these players to craft its most recent bid.

The reasons behind Roche's desire to acquire Illumina are clear. In the age of patent cliffs and managed health care, pharmaceutical companies are exploring various strategies to expand their future revenues. One of the many ways to approach this problem is for huge companies to transition from the role of selling medicines to becoming providers of healthcare solutions. This includes strategies like working with doctors to find the right patients, or working directly with consumers to improve adherence and brand loyalty. For Roche, a company heavily invested in genetic testing and targeted therapeutics, this means integrating DNA sequencing technology at every stage of a drug's lifecycle, from development to clinical trials to use in physicians' offices. The company clearly sees cheap, easy access to a leading sequencing platform as a key to realizing the full potential of their targeted therapeutics. Keeping that goal in mind, though, we wonder why Roche is pursuing a mature company like Illumina rather than one of many cheaper insurgent players.

Roche may now feel the need to acquire a mature company like Illumina because of previous bad experiences in the sequencing realm. In May 2007, Roche purchased 454 Life Sciences from CuraGen for $140 million. At the time the deal was announced, Roche announced that the acquisition would give them a strong foothold in the sequencing space, while also providing 454 with the necessary capital to continue research and development work. However, 454 has never really gained solid market share, and has been under pressure from competitors in recent years. Roche may have seen 454 Life Sciences as a consolation prize in the sequencing game, considering that Illumina announced the purchase of rival Solexa and their technology in an all-stock deal valued at $618 million in November 2006. Now, half a decade later, Roche stands poised to achieve what they couldn't before, and for about 10 times the price. The desire to go after a well-established company like Illumina appears to be a signal from Roche that they don't internally possess the ability to successfully develop and market sequencing technology. If they did, small companies with game changing technology such as Oxford Nanopore, Helicos, or Pacific Biosciences seem like cheaper, more attractive targets.
Roche's current offer for Illumina values the company at six times its 2011 revenue, but Illumina has been forced to spend to stay in the sequencing race, and earnings margins have been slim in recent years. Furthermore, Roche has stated an intention to keep Illumina largely intact after the proposed acquisitions. Considering these facts, it is difficult to see where Roche will find the necessary savings to make this acquisition worth the expenditure. It stands to reason, then, that Roche sees Illumina's technology as a tool to enhance its current and future drug offerings. While most large companies are using acquisitions to revitalize their moribund pipelines, Roche hopes to increase the future value of its clinical and commercial assets by offering integrated diagnostics and treatments to physicians and patients. Only time will tell the success of this strategy, but Roche's previous failed efforts and the high price tag for Illumina don't bode well for the pharmaceutical giant.

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