Limited Downside With Potential Bidding War Upside For GNOM
With the latest developments on the proposals to acquire Complete Genomics (NASDAQ:GNOM), investors have the chance to own shares of the life sciences company with little to no downside and the potential to earn a return of 5% or more in a short period of time. Last week we learned that BGI-Shenzhen’s (BGI) $3.15 per purchase offer had been outdone by genetic sequencing firm Illumina (NASDAQ:ILMN), which offered $3.30 per share to buy the company. GNOM’s Board decided on its own to pass on the ILMN offer without putting it in front of shareholders, claiming anti-trust issues would prevent the ability of Illumina to acquire the company. ILMN, however, has not backed down, and made public a letter to GNOM’s Board of Directors on Wednesday, describing why its offer would pass antitrust scrutiny and why the competing offer from BGI might not. The letter indicates that GNOM’s Board would be remiss not to consider the higher offer and the benefits of dealing with a well-capitalized, U.S.-based company. (See more in our previous story). Considering the letter’s compelling argument and the Board’s fiduciary responsibilities, it would seem that GNOM cannot simply brush aside the higher offer, and as a result, we expect the higher priced deal to be presented to shareholders, sending shares of GNOM higher. Assuming this occurs, BGI could be incentivized to raise its bid, causing a potential bidding war to take place for the asset, which we believe could escalate near the $4.00 per share range. With GNOM currently trading at BGI’s bid price, investors take on little to no risk owning GNOM at current levels, with upside if the higher ILMN offer is made available by GNOM’s Board. Further upside is possible if a bidding war precipitates from the action.
It’s important to focus on the fiduciary responsibility of GNOM’s Board as defined by the Revlon Rule. According to www.translegal.com, the Revlon rule requires Boards of companies that are to be sold to conduct the sale in such a way as to reach a deal that most benefits the corporation’s shareholders. Essentially, when it becomes clear that a corporation is going to be sold, long term corporate plans and interests are set aside and the Board acts merely as “auctioneers” on behalf of shareholders. The Revlon rule is a legal precedent named from a case involving the sale of Revlon, Inc. (Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., Supreme Court of Delaware, 1985, 506 A.2d 173). In that instance, Revlon’s Board fought off a hostile takeover bid by employing a series of defenses and ultimately accepted a lower bid from a white knight. The Delaware Court found that Revlon’s Directors had violated their fiduciary duty of care to their shareholders by accepting the white knight’s bid. We note that GNOM is a Delaware corporation, highlighting the applicability of this ruling in relation to the Revlon rule and the ILMN bid. Members of Boards for emerging healthcare companies that we have spoken with agree that GNOM’s lawyers are likely to advise the company and its Board to allow GNOM investors to vote on the ILMN offer, or else they could be in violation of fiduciary duties under the Revlon rule.
Despite GNOM’s ‘concerns’ that the ILMN offer may not obtain anti-trust approval, the BGI offer also has risk for being scrutinized by the Committee on Foreign Investment in the United States (CFIUS) and regulatory bodies from the People’s Republic of China. Given the argument that both deals have some anti-trust risk, hence the need for regulatory review, GNOM could face legal action if it does not enable shareholders to evaluate the ILMN offer. With only $0.15 per share ($5.2M) standing in the way of BGI taking GNOM without any argument for the ILMN bid, the path of least resistance, of course, is a higher offer from BGI.
What makes GNOM a compelling buyout? The company operates in a growing market, focused on the move toward “personalized treatments”, but differentiates itself by offering services rather than products. GNOM provides whole human genome sequences used by research centers to conduct medical research, which in the future, will be used by doctors and hospitals to improve both prevention and treatment of disease. While competitors like Illumina (NASDAQ:ILMN), Sequenom (NASDAQ:SQNM), and Life Technologies (NASDAQ:LIFE) develop and sell gene sequencing technology, GNOM acts as an outsourcing firm, reducing the need for research facilities to invest in expensive gene sequencing equipment, as well as the costs and labor to conduct the sequencing itself. Because GNOM is staffed with experts that perform gene sequencing regularly, its output to customers produces very efficient and high quality results. The company remains cash-flow negative, as the market is developing more slowly than initially expected, but both BGI and ILMN hope to integrate the growing service-providing aspect of GNOM into their existing operations, which also include outsource offerings. Notably, GNOM has posted revenue growth for the last three years, and although expenses have outweighed sales, the company reported an $18M backlog in 3Q, suggesting that revenues should continue to improve.
GNOM climbed to over $15 per share in mid-2011, supporting a market capitalization of more than $400M, but has hovered around $3 per share for most of this year. We note that the ILMN buy-out offer values the company at less than one-quarter of the company’s peak valuation after factoring in cash on hand. Because investors know the company needs to raise new capital under dilutive circumstances, shares of GNOM remain depressed and vulnerable to acquisition from opportunistic acquirers.
GNOM closed Wednesday at $3.16, a 2% gain for the day that puts share price at just over BGI-Shenzhen’s $3.15 offer. Expectations for a deal with ILMN, following publication of its letter, helped to bolster shares, and the market is leaning towards, at a minimum, gaining access to the ILMN bid. Anything more, specifically if BGI or another purchaser steps in (sources say there may be as many as seven interested parties) would result in upside surprise. At $3.16 a share, we believe speculative investors may find GNOM to be a good risk-reward trade as the take-out saga unfolds.