Many investors who choose to invest in the sector choose, for better to worse, to focus only on the clinical and medicinal aspects of these companies. They choose to tune out the financial and commercial aspects of these companies, and as the case of Illumina (ILMN) & Complete Genomics (GNOM) has shown, that is often the wrong way to approach investing in the sector. Biotechnology companies are, at the end of the day, still publicly traded, and as such they come with all the baggage and benefits of being public. The recent drama between Illumina, BGI-Shenzhen (its largest customer), and Complete Genomics resembles something of a corporate soap opera, and in this article, I will provide an update on where things stand between these three companies, and what the implications are for Complete Genomics.
In June 2012, Complete Genomics announced that it had hired Jefferies & Company to examine strategic alternatives as its losses continued unabated and its cash balances dwindled. In September, Complete announced that it had inked a deal with BGI-Shenzhen in which it would be acquired for $3.15 per share. BGI-Shenzhen is one of China’s leading healthcare companies, and it was China’s representative in the Human Genome Project. Complete Genomics’ LFR (long fragment read) sequencing technology has been shown to be promising (even Illumina CEO Jay Flatley holds that view), but it has never been able to truly build out the technology, due to its weak financial state. Complete Genomics is structurally unprofitable, and it is burning cash. In Q3 2012, the company had a gross margin of 0.66% (that is not a typo; Complete Genomics posted revenues of $7.276 million in Q3 2012 and had a cost of revenue of $7.228 million) and lost 52 cents per share. The company ended Q3 2012 with $34.715 million in cash & equivalents, against debt of $19.436 million, of which $11.202 million is due in 2013. In the first 9 months of 2012, Complete used $43.259 million in cash in its operations, meaning that at its present rate, it is likely that the company will run out of cash in 2013. The deal with BGI-Shenzhen, struck in June, was seen as the solution to the company’s problems that preserved the most value for Complete’s investors. And in my view, some sort of “strategic solution” is necessary. In its latest 10-Q filing, Complete states that,
The announcement and pendency of the Merger [with BGI-Shenzhen] has adversely affected our business, due to customers’ and employees’ uncertainty and other disruptions as well as intensified competition from our competitors as they attempt to take advantage of the uncertainties. Some employees have resigned, and it may be difficult to hire new employees due to the pendency of the Merger. In addition, we have incurred legal and other expenses in connection with the pending Merger. All of these factors are likely to continue to adversely affect our business and have an adverse effect on our financial condition or results of operations.
Complete’s results for Q4 2012 are likely to be worse than its results for Q3, further intensifying the need for Complete to consummate a deal. And for months, it seemed that a deal between Complete Genomics and BGI-Shenzhen was all but finished. Then Illumina entered the picture.
In a 14D-9 filing with the SEC, made on November 13, Complete disclosed that Party H had made a bid of $3.30 per share (representing a 4.76% premium over BGI-Shenzhen’s bid), and that Complete’s board rejected this bid. On November 16, in its own 8-K filing with the SEC, Illumina confirmed that it is Party H, and it reiterated its intention to acquire Complete Genomics. What followed this filing was the start of a corporate soap opera, with both Illumina and BGI-Shenzhen arguing that their offer is best for Complete’s shareholders.
Illumina: Protecting its Customer Base, And Dealing with Competition
For Illumina, a desire to acquire Complete Genomics seems to stem not from a desire to gain control of a fast-growing asset, but from a tactical desire to maintain its market position. In an ironic twist, BGI-Shenzhen is Illumina’s single largest customer, and it is likely that Illumina believes that should BGI gain control of Complete Genomics, it will choose to invest in Complete’s sequencing technology instead of relying on Illumina’s sequencing systems. For Illumina, the loss of its largest customer would be a negative, especially when the company is attempting to diversify away from the academic end-market.
After receiving notice that Complete had rejected its offer, Illumina released the letter it had sent to Complete’s board of directors reiterating its takeover offer on November 20. In its letter, Illumina outlines the rationale behind its offer, suggesting that the deal with BGI-Shenzhen will not pass government review, especially as it relates to a review by CFIUS, the Committee of Foreign investment in the United States. CFIUS has taken a dim view of Chinese companies acquiring control of U.S. companies, and it may not look too kindly upon the idea of a Chinese company being in control of an American company with access to patient data. While there may not be a pressing national security concern relating to a BGI-Complete deal, many of the deals that CFIUS has blocked in the past contained little in the way of “obvious” national security concerns. Furthermore, Illumina adds that a deal with Complete would accelerate competition and innovation in the sequencing market due to the combination of what it calls “game-changing innovations.” Illumina also notes that its offer represents an almost 5% premium to BGI’s offer. It is hard to argue with an extra 15 cents per share. After all, cash is cash. Whatever the true rationale behind Illumina’s bid, investors in Complete Genomics are now faced with 2 offers: one for $3.15 per share, and one for $3.30 per share. Logically, it is obvious which offer is superior: the $3.30 per share offer. BGI-Shenzhen, however, does not see it that way, and it made its opinions on the matter clear in its own letter, sent to Complete Genomics on November 25.
BGI: Protecting a Growth Opportunity
In BGI’s view, it is the company best positioned to help Complete execute its strategy, and it argues that it is an Illumina deal that would be blocked by the government, not a BGI deal. In its letter, the company argues that the FTC would never approve a takeover of Complete by Illumina, given Illumina’s already dominant position in the genetic sequencing market. BGI notes that it will allow Complete to operate as an independent subsidiary, with its headquarters remaining in California. In addition, BGI repeats its assertion that it is a private company with no dealings with the Chinese government, with 100% of its shares owned by its own employees (just like Huawei). BGI ends its letter by essentially accusing Illumina of hypocrisy. The company notes that Illumina has been a partner of BGI for years, and that its concerns about the national security implications of an American sequencing company seem to have surfaced only when it lost out on the opportunity to eliminate a competitor. In this regard, BGI is not wrong. What is the difference between Illumina working with BGI, or Complete Genomics being a subsidiary of BGI? I answer that issue in the next section of my article.
Analyzing the Drama: Who Will Complete the Deal for Complete Genomics?
The drama between Complete, Illumina, and BGI has no clear answers, except for one: Complete is slowly running out of time. The uncertainty regarding its fate has adversely affected its business, and the company is burning cash. While Complete has drawn $6 million of a $30 million loan made by BGI, it’s financial condition is still deteriorating, and the company needs a strategic solution sooner rather than later.
Both Illumina and BGI make a case for why they should be the company that acquires Complete Genomics.
- Illumina: Illumina’s proposal offers Complete’s investors $3.30 per share in cash, and it is difficult to argue with a higher purchase price. Illumina argues that its offer will foster greater innovation in the sequencing market, and that its offer will have an easier time passing a government review. First, there is no CFIUS issue in an Illumina-Complete deal. Secondly, this deal could, in theory, pass an FTC review as well. While it is true that a combined Illumina & Complete Genomics would have a dominant position in the sequencing market, growth in this market has been driven by reductions in the cost of sequencing a genome. Therefore, the FTC could take the view that this deal will do minimal harm to consumers, given that it is unlikely that there will be pricing harm. Illumina is unlikely to raise prices on its customers given the competition posed by Life Technologies (NASDAQ:LIFE) and the pending threat of Oxford Nanopore.
- BGI: BGI is arguing that Illumina’s bid is little more than an attempt to remove a potential competitor from the marketplace, and it is difficult to argue with that view. The desire to keep Complete from developing its technology likely played a large role in Illumina’s decision to launch a bid for the company. Furthermore, BGI notes that it poses no national security threat to the United States, given that Complete will continue to operate as an independent subsidiary, with its American headquarters kept intact. BGI notes that it is strange that Illumina seems to have security concerns regarding BGI, given that the two companies have been partners for years. While this is a valid point, there is one key difference between the BGI-Illumina relationship and the potential BGI-Complete relationship. Illumina is an equal partner in its relationship with BGI. BGI is simply a customer, and it is highly unlikely that Illumina would ever be put into a situation in which it would have to go against the interests of the United States. The same cannot be said of the BGI-Complete relationship. Complete Genomics will remain an independent subsidiary only as long as BGI wishes it to be. In theory, BGI could force Complete to do something that goes against the interests of the United States, and it is this possibility that CFIUS will be examining in a potential review of BGI’s offer to acquire Complete Genomics.
Recent Developments & Conclusions
Complete Genomics has now rejected Illumina’s takeover offer twice, but BGI is nowhere near completing its own takeover bid. The FTC has asked for more information regarding BGI’s offer, and its original tender, set to expire on October 23, has been extended twice, first to November 21, and then to December 14. BGI notes that as of November 20, 44% of Complete’s shares have been tendered. Per the merger agreement between BGI and Complete, BGI needs to hold 90% of Complete’s shares to force the merger through without the remaining 10%. On November 28, yet another potential suitor entered the picture. In a new 14D-9 filing, Complete Genomics disclosed the existence of Party J. In its filing, Complete stated that a judge has blocked a provision in Complete’s confidentiality agreement with Party J that blocks it from making a bid for Complete. Complete has informed Party J that it is now free to make a bid if it wishes. As of this writing, no one has come forward to confirm that they are Party J. Possibilities include either Life Technologies or Roche; those suitors make sense from a strategic point of view, but that is, at this point, educated speculation. On December 3, Illumina announced, in an 8-K filing, that it had made a notification filing with the FTC regarding its proposed takeover of Complete Genomics. A notification filing is the first step in having an acquisition cleared by the FTC, and it indicates that Illumina has not given up on taking control of Complete Genomics.
In the soap opera that surrounds Complete Genomics, there is no clear answer as to who will emerge victorious. BGI and Illumina are both in pursuit, and Party J could enter the arena at any point. But, one thing is clear: Complete Genomics is in need of a solution sooner rather than later. The company’s business is suffering as a result of the uncertainty regarding its future, and a deal needs to be completed as soon as possible to maximize shareholder value.
Update: Party J is a private equity firm.