A day after signing off on Roche’s acquisition of Spark Therapeutics following a 10-month review—a approximately $4.8 billion deal, Spark disclosed December 17 in a regulatory filing—the U.S. Federal Trade Commission (FTC) decided to cast an even warier eye on a smaller billion-dollar life sciences deal.
The FTC said it would block Illumina’s proposed $1.2 billion purchase of Pacific Biosciences (PacBio), alleging in an administrative complaint that Illumina was unlawfully seeking to maintain its monopoly in the U.S. market for next-generation DNA sequencing (NGS) systems by eliminating potential competition from PacBio.
Illumina has defended the deal: “We strongly disagree with the FTC’s decision and will continue to work through the regulatory approval process as we consider next steps,” the company said in a statement. “We believe that the acquisition will benefit the industry and customers, and the facts of our proposed transaction support this.”
The sequencing giant expressed similar arguments after the U.K.’s Competition and Markets Authority (CMA) on October 24 issued provisional findings concluding that the merger will result in a significant loss of competition between Illumina and PacBio. Illumina responded December 12 by rejecting the CMA’s finding, asserting the companies do not compete now, and positioning the deal as potentially lower sequencing costs.
“Illumina has no incentive to redirect R&D investments in PacBio to avoid potential competition that, in its view, cannot occur,” the company argued. “By contrast, there is extensive evidence that Illumina plans to invest in increasing the throughput of PacBio’s systems, thereby reducing sequencing costs for customers, and enhancing competition in the market for native long read systems.
Illumina’s forte has been short-read sequencing; the company no longer offers its TruSeq Synthetic Long-Read DNA Library Prep Kit, launched in 2014, but says on its website it continues to offer customers support and service—as well as partnerships with technology and service providers that include 10x Genomics, Dovetail Genomics, and NRGene. Whatever the outcome of Illumina’s talks with the CMA, and the FTC’s attempt to torpedo the merger, three analysts interviewed in recent days by GEN Edge all agreed that Illumina will remain a sequencing powerhouse even without adding PacBio’s long-read capabilities.
- Mark Massaro, managing director, senior equity analyst, Canaccord Genuity
- Puneet Souda, managing director, Life Science Tools and Diagnostics, SVB Leerink
- Julie Utterback, CFA, vice president, Healthcare, Morningstar
Following are responses from all three analysts, edited for length and clarity:
What effect will the FTC’s action have on Illumina? How much of a long-term headwind is this for Illumina?
Souda: For Illumina, it is not a headwind by any means, simply because Illumina has been driving innovation and the sequencing market in terms of next-generation sequencing in oncology and population studies and broader end markets, largely because of their short-read technology, or SBS [sequencing by synthesis] chemistry.
Having PacBio is not a necessity. It would be a plus to have long-read sequencing in addition to some short-read data—the combination of both short-read data and long-read data could be useful in a number of applications, but that’s largely dependent on if the deal gets approved.
Utterback: The potential PacBio acquisition is not a significant driver of our fair value estimate for Illumina given the target’s relatively small size.
[Morningstar trimmed its fair value estimate for Illumina in September from $275 a share to $264 a share, after lowering its expectations for growth, particularly in 2019, and for margin expansion throughout the firm’s five-year forecast period. Illumina shares closed December 27 at $332.29.]
In fact, a blocked deal may even have a slightly positive effect on Illumina’s stock in the near term given the rich valuation we think is being offered for PacBio.
Massaro: I don’t think it’s a long-term headwind at all. I don’t know why it would be. Illumina has a terrific business without PacBio. They’re on track to do $3.5 billion in revenue this year, and well over $6 of earnings per share. That’s 30% operating margin, and they have a terrific business with no PacBio, so I believe that there is zero long-term impact related to this potential acquisition.
What does the FTC’s challenge mean for PacBio?
Massaro: I’m looking at the stock price of PacBio [Friday as of 3 p.m. ET]. It’s $5.32. The stock is down considerably from the $8 a share purchase price [agreed upon by the companies]. So, I guess the long-term impact if this deal doesn’t go through is that PacBio likely is trading at roughly the same level of where it was trading at before the merger agreement, which was approximately $4. I would say the upside is $8 if it closes, and the downside is roughly $4.
[PacBio shares closed at $5.24 on December 27.]
Utterback: For PacBio, blocking the combination would likely put more pressure on the organization to succeed as an independent organization or find another suitor. Illumina’s extension of the merger agreement to March 2020 and expected $28 million in payments to PacBio during the interim period should provide a bit of a buffer for the acquisition target, but its ongoing cash burn rate should remain a key concern for PacBio investors.
Should the Illumina-PacBio merger fall through, what effect would that have on Illumina’s long-read sequencing capabilities?
Utterback: A blocked merger would put more pressure on Illumina to continue innovating internally in the long run, as future acquisitions of commercialized sequencing technology may face similar antitrust scrutiny.
Massaro: Either Illumina could develop their own long-read sequencing, or they could choose to never launch a long-read. They’re doing just fine without them, and if they had them, they think that they could take their product suite offering to the next level. But without them, they’re still the dominant player in next-gen sequencing.
Souda: When it comes to speed, accuracy, and the throughput, short read is delivering that in the market. Long-read is useful in certain aspects when you combine those datasets, or in certain cases when short-read sequencing is refractory to certain measurements, in those cases, you can use long-read sequencing to get more information. It’s not necessary that Illumina needs that specifically. But it would be a positive.
What is the effect of the FTC action on the broader next-gen sequencing market: Does this help or hinder other developers of next-gen sequencing technologies, or both, and how?
Utterback: I can see it both ways. In general, though, the FTC appears most concerned about Illumina’s monopolist-like power, rather than PacBio being acquired. So, if Illumina is blocked from merging with PacBio, perhaps another firm interested in expanding into sequencing could purchase PacBio, and provide a significant competitive threat to Illumina in the long run.
In general, the threat of disruptive technology and new competitive forces remain a key concern for Illumina’s long-term prospects, which keeps our moat rating on the organization at narrow rather than wide.
[Morningstar defines companies with a “narrow” moat rating as those it believes “are more likely than not to achieve normalized excess returns for at least the next 10 years.”]
On the other hand, if this FTC decision effectively removes a key exit strategy from the sequencing market [selling to industry leader Illumina], there may be less capital thrown at startups in the industry, which could hurt technology development.
Souda: I don’t think it has any impact on the broader market. We have a number of private companies that are emerging with newer technologies I the space. Obviously, they are very small, and hold significant potential, both in terms of short-read sequencing, long-read sequencing, or other approaches that they are introducing into the market.
Massaro: I don’t think it helps or hinders. I think it has no—I don’t think there’s any long-term repercussions from this decision, no matter how it goes.
Any examples of up-and-comers in sequencing that hold potential? And can PacBio be pushed into some other company’s arms?
Massaro: The other big player in the space is Thermo Fisher. When I look at the market share dynamics in sequencing, it’s my estimate that Illumina has roughly 80% of all the sequencing systems placed, and roughly 90% of all the sequencing consumables. That leaves Thermo Fisher to have less than 10% of the consumables.
I’ll just say that I don’t think the regulators would have any problem with Thermo Fisher acquiring PacBio.
Frankly, a lot of analysts, including myself, were surprised when Illumina announced this deal immediately. And as I wrote in one of my notes, not that long ago, I’m on record saying this deal appears unlikely to close.
Souda: Thermo is a short-read technology. Oxford Nanopore Technologies has long read nanopore technology; everybody has their different technologies. There are other private companies, but again, we have not seen a lot of data just yet. It remains to be seen if that dataset is going to be promising over the long run. Last year, Agilent acquired Lasergen, which again I believe is also a short-read sequencing technology. And it’s focused more on sort of a diagnostic approach, not necessary a research or a population sequencing approach.
Has the FTC become the biggest hurdle to life sciences M&A?
Massaro: It’s not just the FTC though. The UK CMA had issues. This is about accelerating the concentration of one company in an industry. And there are hundreds of cases of deals like this getting blocked. So this is nothing new. This is nothing new, and it’s not a surprise.
Souda: I don’t think so—these are very specific situations that happen to be a fairly mature long-read sequencing company in this space, and Illumina is trying to acquire a mature company. In June, Thermo Fisher’s acquisition of Gatan was terminated after the UK CMA got involved. The FTC was not involved.
Next-generation sequencing holds enormous market potential, so you will see more entrants coming to a much larger market. Again, that situation was very specific to Thermo and Gatan. And I don’t think it’s reflective of anything that would happen in the longer-term, either across the industry or with Illumina or with Thermo Fisher.