Is Roche's takeover bid a good investment?
The pharmaceutical company thinks Illumina is a good fit with its business strategy.
Many financial analysts believed the offer to be light, and speculation about an increased offer prompted Illumina shares to rise 46% Wednesday to close at $55.15. In a note to clients, Wedbush analyst Zarak Khurshid stated that Roche would likely sweeten its offer. Wedbush raised its price target on Illumina to $50 from $35.
The offer from Roche comes at an inopportune time for Illumina, as its stock price had been trading nearly 50% off its mid-2011 levels. The company had previously slashed revenue guidance as a result of reduced government spending -- something it relies heavily on. As a result, Illumina announced a restructuring program in October worth $15-17 million to compensate for reduced research funding.
The appeal of Illumina is derived primarily from its genetic sequencing machine, which would allow doctors to view the entire DNA sequence of a patient within a single day, rather than the weeks or months that the current technology requires. The company previously announced that it would market these machines by the second half of 2012. The company also hopes to drive down the cost of genetic sequencing from its current price of $5,000 to under $1,000 per patient within five years.
Roche's portfolio is heavily comprised of cancer treatments. Genetics plays a large role in cancer research, which researchers depend on for disease detection, progression, and treatment. They also allow doctors to predict how a patient will react to a treatment and whether side effects could occur.
The usage of sequencing can show abnormalities in body tissue DNA and aberrations in cancer tumors -- two critical factors when analyzing a cancer patient's prognosis that could not be made visible any other way.
Genetic sequencing is considered to be a very significant medical development because it allows each patient to forecast what kinds of disease and illnesses that he or she is at risk for. It also would allow doctors to make more accurate treatment recommendations, and significantly cut the risk of a misdiagnosis. A deeper understanding of cellular biology would also allow other pharmaceutical companies to develop new medications and devices.
While genetic sequencing remains a promising development for patients, it remains to be seen whether Illumina can grow revenue from it. As costs to have the process done continue to fall, Illumina could have trouble expanding margins, given that sequencing is only done once for each patient and does not need to be repeated. Its best hope is that the process will become cheap enough to be covered by insurance, so that everyone can have it done as part of a health maintenance regiment.
If you believe in the potential of genetic sequencing, you should consider these trades:
- Go long Illumina. Many analysts have stated that Roche could increase their offer to convince shareholders to agree to the hostile takeover.
- Go long another molecular diagnostic company like Myriad Genetics (MYGN). Myriad Genetics is one of the last independent genetic sequencing companies out there, and many analysts have forecasted additional consolidation within the sector.
If you believe that the genetic sequencing bubble has been broken, consider these trades:
- Go short Illumina. The stock is currently trading at $54, a significant premium above Roche's offer of $44. Roche has stated that it has no plans to increase its offer and that it represents a fair value for the company.
- Go short Roche (RHHBY). As the individual cost for genetic sequencing falls, the margins for Illumina will likely fall with it. If Illumina cannot grow revenues from the process, Roche's new acquisition will turn out to be an expensive failure.
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John Stumpf acknowledges that growth has been slow, but he says he's still optimistic.
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