It wasn't that long ago that I mused about Roche (OTCQX:RHHBY) having lost its way and much of its relevance in the life sciences space. With a bold announcement Tuesday night, it looks like this Swiss medical giant is looking to fix this problem in a big way. Roche is proposing to acquire sequencing giant Illumina (ILMN) for $44.50 in cash.
The Proposed Deal
At the proposed price, Roche is offering to pay Illumina investors an 18% premium over Tuesday's close, but a 60% premium to Illumina's price when rumors of a possible deal started lifting these shares up off the mat. If the deal goes through, Roche will be paying a lofty 18 times trailing EBTIDA and more than five times trailing revenue.
That may be a reasonably large "if", though. Like most companies in the med-tech space, Roche prefers to keep things quiet and relatively friendly. The fact that Roche is taking this approach suggests that Illumina either turned them down flat or held out for a sweeter price. Now Roche is looking for shareholders to apply pressure on the Illumina board to sit down at the bargaining table.
Does This Deal Make Sense?
Illumina has built itself into the market leader in sequencing. Even with some recent competitive gains by Life Technologies (LIFE) and its SOLiD and Ion Torrent platform, Illumina has done an enviable job of staying on the leading edge of technology and maintaining a good reputation with the academic research community.
While analysts once fretted about the risks of competition from up-and-comers like Pacific Biosciences (PACB), Oxford Nanopore, Helicos, or Wafergen, the most recent iterations from Illumina (and to a lesser extent Life Technologies) have largely sucked the air (and money) out of the labs.
But does the deal make sense? Right now, the entire life sciences sector is churning through tougher times caused by significant reductions in government-funded grants. As Illumina is heavily dependent upon academic research labs as customers, that's a problem and a proximate cause of the disappointing results that pushed the stock to multi-year lows in 2011.
Roche has an existing sequencing and life science tools business, but the acquisition of Illumina isn't going to cause that much overlap given how far 454 has fallen behind. What Roche can do, though, is use its leverage in diagnostics to facilitate the transition of Illumina's tools from the research labs to diagnostics labs. Where Illumina has had difficulty penetrating into hospitals and diagnostic labs and lags companies like Luminex (LMNX), Bio-Rad (BIO), Becton Dickinson (BDX) and Gen-Probe (GPRO), Roche may be able to better guide product development.
Where To From Here?
There's a slim chance that Illumina could find a white knight acquirer. General Electric (GE) supposedly had interest in this market, but it's anybody's guess as to whether that's mostly wishful thinking on the part of analysts and investors. It's also at least conceivable that a company like Abbott (ABT) or ThermoFisher (TMO) would answer the phone if the bankers called.
Unfortunately, the reality is that there isn't going to be a surplus of buyers willing to pay a big premium to get into a business that depends heavily on federal government budgets, demands constant R&D reinvestment, and has yet to offer really outstanding returns on capital. Then again, it's still a high-growth opportunity and the potential in commercial diagnostics and drug development (to say nothing of synergistic internal development) is valid.
Roche certainly has some experience in hostile deals, as the transformative acquisition of Genentech did get rather contentious along the way. Odds are good that management is prepared to pay more and investors should not be surprised if the bid approaches (or exceeds) $50 a share for Illumina. As just a sequencing company, it's a bad deal for Roche - but the potential of building on that technology and developing products better-suited for the diagnostic lab and Big Pharma R&D lab makes it an interesting gamble.
For Illumina shareholders, the reality is that this likely the best chance of getting this sort of valuation any time soon. Now that investors have seen how dependent Illumina is on federal budgets, it doesn't seem credible that they will pay quite the same multiples as in the past. Illumina could conceivably move its technology into diagnostics on its own, but Roche's bid is a reasonable way of cashing out with a solid risk-free return.