Roche looks to beef up diagnostics with Illumina offer

With technology that can sequence a human genome in less than a day as an enticement, Roche’s hostile $5.7bn offer to buy out California group Illumina is a play to add new capabilities to its already strong diagnostics arm - with an eye on the long-term needs of its pharma business.

In the near term, the Swiss company believes that its sales muscle will enable greater penetration of genome sequencing tools into a growing number of hospitals and physician practices, where it can be used to refine patient care. As a longer term proposition, the skills brought on board with the transaction could assist in the development of the companion diagnostics that are growing in importance particularly in cancer treatment. The two taken together could prove a Roche strength in coming years but it seems it will have to offer a lot more to seal the deal - Illumina shares were trading at $53.81 in early trade, substantially higher than the $44.50 per share bid on the table.

Established business

The $44.50 per share offer comes in at an 18% premium on Illumina's closing price yesterday and, as Roche was quick to emphasise, a 64% premium on the price of December 21, the day before rumours of a buyout began pushing the stock higher. It would mark the biggest diagnostics buyout for Roche, outstripping its $3.4bn acquisition of Ventana in 2008, and would be the largest for the corporation since Genentech at $46.8bn in 2008.

As it is an established cash-generating business, Roche executives forecast the transaction would add to profits in the first year following its close – some analysts, however, believe it will be earnings neutral. But, those estimates presume that the $5.7bn offer will stand; Illumina shares soared this morning, presaging a potential higher offer from Roche, something it did in both the Ventana and Genentech’s transactions, or another party.

Even a price above $50 would be a disappointment, however, to those Illumina investors who bought as recently as last July, when the price was topping $70. Prior to its late July fall and the market meltdown of August, Illumina had spent all of 2011 above $60. Given an earlier rebuff from the Illumina board of a $40 per share bid and today’s increase, Roche’s price will almost certainly need to raise again to complete the deal.

In a sign that investors think this is a trend that might continue, shares in fellow diagnostics companies were on the rise today: Life Technologies, which also performs one-day genome sequencing, was up 5% to $49.64 in early trading, while Pacific Biosciences climbed 10% to $4.36.

Strategic outlook

Roche itself markets genetic sequencing technology, but sees its business as complementary to Illumina’s. The smaller company’s strength lies in “short read” applications such as whole genome resequencing whilst Roche’s is in “long read” applications. Where Roche believes it can advance Illumina’s technology line is in markets outside the US, where Roche does more than three-quarters of its business, and penetrating into hospitals and universities, where Roche has established business, rather than research centres.

Neither company’s sequencing technologies is used routinely in clinical diagnosis, something the Roche executive team believes will be changing as diagnostic technologies increasingly are seen as adding value to therapeutic products. The outlook in the US is slightly more difficult from a regulatory perspective – the FDA must approve diagnostic technology – but in Europe all sequencing technologies have regulatory sign-off in the form of a CE mark.
As with collaboration between the existing Roche diagnostics staff and its pharmaceutical development staff, executives hope the addition of expertise from Illumina will aid in the development of genetically based personalised medicine products.

As a sign of the growing importance of personalised medicine in oncology, two cancer treatments approved in 2011, Pfizer’s Xalkori and Roche’s own Zelboraf, were approved in tandem with companion diagnostic tests. Whilst neither uses sequencing technology, the Roche team believes a day is coming when it will be used more routinely as a greater number of mutations are identified with specific disease conditions.

Making it pay

As analysts from Bernstein note, genomics so far has proven mostly successful in oncology, where the genetics are comparatively simple, while having little effect on more complex conditions like cardiovascular disease.

With FDA guidelines in place outlining a parallel approval track for companion diagnostics, the table has been set for more of such tests to reach the market (FDA guidance reinforces importance of companion diagnostics, July 14, 2011). Reimbursement, however, remains an issue (BIO 2011 – Diagnostics want barriers to compensation torn down, June 30, 2011), although Roche diagnostics chief Daniel O’Day contends of sequencing, “I’m confident as with other diagnostic applications once you have robust clinical data around it, the next step is of course reimbursement.”

That is, of course, a long view of the transaction. The more immediate one is the likely need for Roche to sweeten its offer. Given today’s share price move, Roche will need to put significantly more cash on the table to snare Illumina.

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