Is Roche's takeover bid a good investment?

The pharmaceutical company thinks Illumina is a good fit with its business strategy.

By Benzinga Jan 25, 2012 8:00PM

Image: Medical doctor (© tetra images/Getty Images/Getty Images)By Jay Wong, Benzinga Staff Writer


Swiss pharmaceutical giant Roche (RHHBY) announced Wednesday a hostile takeover bid for Illumina (ILMN) worth $5.7 billion in cash, or $44.50 per share. 


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.


ACTION ITEMS:

Bullish:
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.
Bearish:
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.
Neither Benzinga nor its staff offer investment advice, nor do they recommend that you buy, sell, or hold any security. 

More from Benzinga:
8Comments
Jan 26, 2012 9:05AM
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I held MYGN for quite some time. Interesting idea, but I've run to cash in recent months. If M&A picks back up in the sector, I might consider the stock.
Jan 26, 2012 2:09AM
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Interesting trading ideas, does Benzinga always include those at the bottom of its articles? I would be interested in the arb boys who got crushed today with all that volatility over the buyout price.
Jan 25, 2012 11:04PM
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Anyone out there remember Warner-Lambert? $90 billion later, and of course not but everyone does know Viagra, Pfizer, and Lipitor... Illumina's mv will be the decider but $44.50 is no way the end of the story.

Plus, Illumina's board is takeover-filibuster w/ their rotating elections & Roche got a no from the $40 offer.  

anyway I don't much care for bio/pharma but if I see an entry I'm in.
Jan 25, 2012 9:25PM
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This seems to be all on chance, not sure that I'd want to invest in this company--doesn't seem particularly stable at the moment. 
Jan 26, 2012 4:07PM
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Price is too high, but who am I to disagree? Fine article by the way
Jan 26, 2012 1:27PM
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ILMN just this morning announced a poison pill!! i.e. shareholder rights plan against hostile takeovers
Jan 26, 2012 10:57AM
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Still seems up in the air but def. worth a flutter.
Jan 26, 2012 9:37AM
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The price of genetic sequencing is already falling, if Illumina can market it correctly then it will be great otherwise it will be very easy for someone else to sneak into the space.
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