Roche's Illumina Bid May Start War

NEW YORK ( TheStreet) -- With news breaking late on Tuesday of Roche's hostile $5.7 billion offer for Illumina ( ILMN), M&A watchers would be wise to remember a similar-sized deal that eventually turned a hostile and resulted in a new buyer and a 20% price increase.

In March, 2011, Valeant Pharmaceuticals ( VRX) took a $5.7 billion bid for Cephalon directly to the company shareholders after management called the offer "opportunistic" and talks stalled. The move caused shares to surge above the $73 a share bid price.

While the bid eventually failed , optimistic investors were vindicated by a $6.8 billion competing bid from Teva Pharmaceuticals ( TEVA), which valued the company at $81.50 a share.

That same dynamic may play out in Roche's offer for Illumina.

Illumina shares rose nearly 43% to $53.89 in afternoon trading, roughly 20% more than Roche's $44.50 a share bid, indicating that investors expect an increase. While Roche's offer may be "opportunistic" as Illumina's management argues in a statement, the share surge could reflect an expectation that other suitors will enter the bidding fray now that the process is public.

"We are increasing our price target for Illumina to $49.50 to reflect the potential for a broader sale process following Roche's recent announcement of a hostile bid," wrote Deutsche Bank analyst Ross Muken in a Wednesday note. Price target increases by analysts across Wall Street pegged Illumina's value as high $70, citing the potential for a bid increase and an overall need to boost earnings multiple-based valuations for the San Diego-based genomics and diagnostics specialist.

The big story of the day is what will happen with Roche's bid. As the Illumina management weighs whether it will recommend the offer to its shareholders, other interested parties could jump in and push up the offer price.

Siemens ( SIE) and Johnson & Johnson ( JNJ) have been previously reported as having complimentary operations to Illumina's the diagnostics and genomic sequencing businesses, says Muken of Deutsche Bank in a follow up conversation. "Given Illumina's unique strategic nature, there are probably a reasonable number of companies that might be attracted to it," he adds, citing the importance of the company's machinery to genomics based research and the potential for use of them in patient cancer diagnostics that could drive double digit sales growth.

"Periods of M&A in the space of diagnostics and tools come in waves," notes Muken. While development of speedier and lower-cost genomic sequencing machinery faces typical research and development risks, Muken adds that it's less of a risk as oncology and cancer drug development R&D risks, potentially leading to a diverse interest from the likes of Siemens, Johnson & Johnson, in addition to Abbott Laboratories ( ABT), Becton, Dickinson ( BDX) and Philips Research.

If a new bidder were to emerge, Roche's hostile offer could mirror the bidding war that Valeant and Teva waged for Cephalon, which yielded a $6.8 billion merger and a 20% premium to the initial offer. To be seen is whether any new parties will step into the fray for Illumina or at what premium.

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For more on Illumina shares, see "8 biotech stocks to watch.

Meanwhile, Roche's bid provided a windfall to Illumina competitors who are developing genetic sequencing machinery for research labs to study cancer tumors that may assist treatments for individuals as costs and sequencing times come down.

The stocks of Illumina's competitors Life Technologies ( LIFE), Pacific Biosciences of California ( PACB) and Complete Genomics ( GNOM) surged roughly 3%, 15% and 23% respectively. Illumina and its competitors may bring sequencing time horizons down from weeks and even months to just a day, potentially lowering costs enough to make them increasingly affordable for patient care.

" We expect other stocks with direct exposure to sequencing (Life Technologies, Pacific Biosciences of California and Complete Genomics) will enjoy a sympathetic boost," wrote Leerink Swann analyst Dan Leonard in a note reacting to Roche's bid. However, Leonard tempers expectations of an M&A wave. "I don't think any of the companies I mentioned in the note are going to get an offer in a near term," said Leonard in a follow up conversation. Instead, he believes that Roche's interest is in Illumina cause for investors to reevaluate the growth prospects of the sequencing market.

Putting aside a potential new bidder for Illumina, Roche's bid could rise on simple valuation concerns. Jefferies analyst Jeffery Holford said in a Jan. 25 note that while Illumina's bid makes strategic sense, the $44.50 price is "opportunistic" and will likely need to be increased. JPMorgan analysts increased their price target for Illumina's shares by 60% to $70 a share, calling the bid too low for a technology leader in an open-ended market like genetic sequencing machinery.

"We believe the offer price underappreciates the free cash flow generation by the company," adds Wedbush Securities analyst Zarak Khurshid in a note upgrading Illumina's price target to $50 a share from $35.

Analysts currently give Illumina a price target of $41.91 a share, according to consensus estimates polled by Bloomberg. The company is expected to earn 28 cents in earnings per share when it reports its fourth quarter earnings on Jan. 31, according to estimates compiled by "Zacks. In its previous two quarters, Illumina missed Zacks consensus earnings estimates.

Presently, Roche is willing to pay a significant premium for Illumina's sequencing machinery, in spite of slowing earnings. The offer values Illumina at 32 times its 2012 profit estimates of $1.39 a share, according to Bloomberg. Nevertheless, that bid is below Illumina's historical three year average of 38 times earnings, making the firm's intrinsic value closer to $70 a share, according to William Blair analysts.

Illumina's board will now need to review Roche's offer and recommend action for shareholders, the company said in a statement. Goldman Sachs and Bank of America Merrill Lynch are acting as financial advisers to Illumina. Greenhill & Co. and Citigroup are Roche's financial advisers

-- Written by Antoine Gara in New York

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