You can now scratch one of the most highly anticipated healthcare IPOs off the list. It's not happening.
Illumina (NASDAQ: ILMN) announced on Monday morning that it plans to acquire GRAIL for $8 billion. The news came less than two weeks after GRAIL filed for an IPO. The deal confirmed reports that surfaced last week about Illumina's interest in buying the cancer diagnostics start-up.
But many investors aren't fans of this acquisition. Is Illumina making an $8 billion blunder?
As a privately held company, GRAIL has received investments of close to $2 billion. Some investors might not be happy campers that Illumina is paying four times that amount to buy the small cancer diagnostics company. The price tag is especially ironic considering that Illumina founded GRAIL in 2016, but later spun it off as a stand-alone entity.
The total cost of buying GRAIL is even greater than the upfront investment. GRAIL shareholders will receive contingent value rights (CVRs) that allow them to receive part of revenue generated by GRAIL. These CVRs enable GRAIL shareholders to get 2.5% of the first $1 billion in annual revenue for 12 years, plus 9% of annual revenue above $1 billion during the period.
Another major concern is whether or not GRAIL is even a good fit for Illumina. GRAIL is developing a liquid biopsy product, Galleri. Liquid biopsies detect cancer by identifying DNA fragments in the blood that have broken off from tumor cells. Illumina markets the next-generation sequencing (NGS) systems used to sequence the DNA for Galleri.
It's possible that Illumina's acquisition of GRAIL could hurt its relationships with other customers. Analysts with Cowen, for example, wrote to their clients that "almost every one of Illumina's major clinical customers has (and many emerging customers) ambitions to develop liquid biopsy based cancer screening tools." One of the current leaders in the liquid biopsy market, Guardant Health, has been an Illumina customer since 2014.
Illumina's big bet
Illumina, though, thinks that its big bet makes a lot of sense. The company expects the NGS testing market to reach $75 billion per year by 2035. GRAIL won't have to capture too large a share of this potential market for Illumina's investment to pay off.
The company would also likely argue that what it's paying for GRAIL isn't too excessive. GRAIL's now-scuttled IPO could have valued the cancer diagnostics start-up at $6 billion or more.
Illumina might not have to wait very long for its GRAIL investment to begin delivering a return. The company anticipates that the transaction will be accretive to revenue beginning next year, with much higher revenue growth in subsequent years.
But what about potential harm to its existing customer relationships? Illumina believes that it will be able to thread the needle. The company stated, "With GRAIL, Illumina will continue as a leading sequencing innovator and partner, while also becoming a proprietary test provider."
It's important to note that Illumina already owned 14.5% of GRAIL's outstanding shares. Customers with their own liquid biopsy programs were already aware of Illumina's stake in GRAIL. With Illumina planning for GRAIL to operate as a stand-alone division, it's possible that the customer impact won't be as great as critics of the deal expect.
I think that the collapse of Illumina's previous attempt to acquire Pacific BioSciences of California put the company in a position where it needed to make some sort of strategic deal to spur growth. GRAIL might not be the ideal acquisition candidate, but it's not a horrible one.
It's too soon to know if Illumina's $8 billion investment will provide the kind of returns that will be a major catalyst in the future for the healthcare stock. However, I wouldn't call Illumina's planned acquisition of GRAIL a big blunder at this point. Sure, the buyout could present some challenges for Illumina. On the other hand, it could also open up additional growth opportunities for the company. Only time will tell if Illumina's move is brilliant or boneheaded.
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