Seeking to solidify its position in the personalized health care market and add to its research instrument business, on January 25, Roche announced a $5.7 billion unsolicited proposal to acquire Illumina (see page 2). The announcement further bolstered expectations surrounding the use of post-Sanger sequencing, especially next-generation sequencing, in clinical and in vitro diagnostic (IVD) markets. Both Illumina and Life Technologies plan to submit their respective MiSeq and Ion PGM systems for FDA approval this year.

The acquisition would benefit both Roche’s Pharmaceutical and Diagnostics Division. As Daniel O’Day, COO of Roche Diagnostics, stated, “Our ability to offer a total solution to researchers will help 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.”

In announcing the offer, Roche cited four key reasons for the acquisition: increased participation in the sequencing market, a stronger research and IVD product portfolio, the ability to unlock the commercial potential for sequencing and entry into the IVD sequencing market. Although Roche 454 currently sells a competing next-generation sequencing technology based on pyrosequencing, Illumina’s sequencing-by-synthesis technology has gained a leading market share. Utilizing shorter read lengths, faster sample preparation times along with advanced informatics capabilities, Illumina’s next-generation systems offer a competitive advantage in many fast-growing applications, including clinical applications, due to the high-throughput and low costs.

On its conference call, Roche stated that the acquisition would allow it to offer both long-read and short-read sequencing technologies and thus cover a wide spectrum of research and clinical applications. Similarly, Roche presented a view that Illumina’s high-throughput bead microarray business would complement its low-throughput Roche NimbleGen in situ synthesized microarray offerings. Roche stated in the proxy for the offer that it would not divest its microarray business.

Roche also made the case that its geographic and customer base and expertise in the clinical and IVD markets would enable it to expand Illumina’s business in the research market and, most importantly, into the IVD market. “Roche has now more than 30 years of experience in taking products from the research setting into the IVD setting,” commented Mr. O’Day. “There are many hurdles that exist in terms of being able to do this successfully, and we routinely do it successfully.”

Roche also discussed the synergies between Illumina and its $37 billion pharmaceutical business. “In the mid- to longer-term, we see this also playing into our model of PHC [personalized health care], which, as you know, within the Roche Group today, we have more than 160 collaborations alone between our Pharma and our Diagnostic colleagues, leading to a very robust late-stage pipeline of companion diagnostics,” said Mr. O’Day. “Sequencing can be yet another tool for complex genetic variations that we can put into the system and allow us to amortize both the benefit to Diagnostics as well as the benefit to Pharma and to the Roche Group.”

Roche would combine its Applied Science business with Illumina and move the headquarters from the Applied Science location in Penzberg, Germany, to Illumina’s headquarters in San Diego, California. The company would also maintain operations in Penzberg. Roche’s Applied Science business sells sequencing, microarray, PCR, cell analysis instruments and reagents for research applications. It also includes the Custom Biotech unit, which provides biochemical reagents for research, diagnostics and manufacturing. In 2010, Roche Applied Science revenues totaled CHF 868 million ($835 million= CHF 1.04 = $1).

Roche’s offer for Illumina came just over a month after Roche first met with Illumina to discuss the possibility of an acquisition. Subsequent discussions included Roche’s concern about Illumina’s slow response. In January, Illumina engaged financial advisors and, on January 17, its Board convened to discuss the proposal. The following day, Illumina notified Roche that it was declining the offer.

In line with the initial announcement, Roche’s began the tender offer on January 27 at a price of $44.50 per share. This was one day after Illumina enacted a “poison pill” resolution to deter hostile takeovers by giving shareholders the right to purchase additional shares at half the price should any group attempt to acquire 15% or more of outstanding shares.

At month end, Roche reaffirmed its plan to remove the “poison pill” by nominating four directors to replace those up for election at Illumina’s shareholder meeting this spring. In addition, Roche plans to propose to increase the number of seats on the board from nine to eleven and nominate another two directors. On January 27, Illumina stated it would advise shareholders of its formal position within 10 business days of the offer date.

Roche’s bid of $44.50 represents an 18% increase over Illumina’s closing price on January 24, but is a 64% premium over the price prior to acquisition rumors. However, Illumina was trading at depressed levels not experienced since the financial crisis in 2009. The company was negatively affected by lower academic funding and excess sequencing capacity during the second half of 2011 (see IBO 8/31/11). Government and academic spending accounts for 80% of its sales and roughly one-third of revenues are derived from the NIH budget.

Illumina is expecting its clinical and diagnostic businesses to diversify its revenue sources. In its JP Morgan presentation in January, the firm highlighted the rapid uptake of MiSeq in clinical markets and estimated the sequencing markets for clinical trials, cancer–normal pair analysis and newborn sequencing over the next few years at $24 million, $250 million and $350 million, respectively.

The Roche offer comes just two months after Illumina partnered with Siemens to adapt MiSeq to run Siemens’ infectious-disease assays (see IBO 12/31/11). Illumina also signed deals last year with Sequenom and Verinata to provide sequencing technology for noninvasive prenatal tests, which will be submitted for FDA approval.

Roche’s offer for Illumina indicates the pace at which next-generation sequencing is entering the clinic and its potential for IVD use. “This technology is quickly moving from high-level research to routine use in the hospital setting,” said Mr. O’Day, noting its use at major cancer centers. Roche’s bid for Illumina could influence the progress.

 Bar Graph: Illumina Quarterly Revenues

                              2009                        2010                        2011

                    Q1     Q2     Q3     Q4     Q1     Q2     Q3     Q4      Q1      Q2      Q3

 Sales           165.8  161.6  158.4  180.6  192.1  212.0  237.3  261.3   282.5   287.5   235.5

 Adj. Op. Profit  39.1   39.7   33.2   38.3   40.8   51.8   60.5   61.5    77.3    79.4    44.4