Europe stands in the way of Illumina's (ILMN) strategic vision.
The DNA-sequencing titan in November 2018 proposed to acquire smaller peer PacBio (PACB). The deal would've given Illumina the tools it needed to keep up-and-coming challenger Oxford Nanopore Technologies (ONTTF) at bay – at least for a little while longer.
The merger never closed. Trade regulators in the UK, where Oxford Nanopore is based, stepped in to block the acquisition and protect one of its homegrown technological gems.
European regulators are now taking their turn. In September 2020 Illumina said it would acquire liquid-biopsy developer Grail. In the face of inquiries from regulators in the U.S. and Europe, the DNA-sequencing company closed the acquisition in 2021.
It was a risky move – and now the bill is coming due.
The European Commission completed a formal investigation that found its initial anticompetitive concerns were valid. Regulators have now ordered Illumina to divest Grail.
What happens now?
Executive Vice President Margrethe Vestager summarized the findings of the investigation:
Today we prohibited Illumina's implemented acquisition of GRAIL. In a race with other companies, GRAIL is developing a blood-based early cancer detection test. If successful, these tests will revolutionise our fight against cancer and help to save millions of lives. Illumina is currently the only credible supplier of a technology allowing to develop and process these tests. With this transaction, Illumina would have an incentive to cut off GRAIL's rivals from accessing its technology, or otherwise disadvantage them. It is vital to preserve competition between early cancer detection test developers at this critical stage of development. As Illumina did not put forward remedies that would have solved our concerns, we prohibited the merger.
To summarize: Regulators found that Illumina had both the ability and the incentive to prevent liquid-biopsy developers from competing on a level playing field.
Although the industry titan offered potential remedies, the commission didn't think they would suffice.
It marks only the 10th merger to be blocked by the EC in the past 10 years, compared with more than 3,000 mergers that were approved after routine review.
What Happens Now?
Let's try to keep track of all the moving parts.
Before the September 2022 announcement, the European Commission imposed a fine of 10% of global revenue for proceeding with the Grail acquisition before its official review was completed. This is referred to as breaching the standstill obligation.
Illumina in Q2 2022 set aside $453 million – one-tenth of combined revenue since the acquisition was completed – to ensure compliance, although it promised to appeal the decision at the time.
Regulators may accept the divestiture of Grail in lieu of the fine for breaching the standstill obligation. And Illumina can still appeal the fine if the regulators don't budge. But investors must take note that the company may need to both divest the acquisition and pay the nearly $500 million fine.
It's possible the DNA-sequencing leader still comes out on top, but the odds are dwindling. Illumina intends to appeal the Commission's decision to block the acquisition. Meanwhile, the U.S. Federal Trade Commission intends to appeal a judge's recent decision to allow the merger to proceed.
The fact that the acquisition is being squeezed by regulators on two continents isn't a promising sign.
It gets even messier.
Illumina agreed to pay Grail a termination fee of $300 million if the merger wasn't completed. There were carveouts for terminations triggered by government agencies and specific deadlines, according to Securities and Exchange Commission filings. Technically, the acquisition was completed in 2021. Whether a termination fee or break fee applies now isn't clear.
Termination payment or not, the timing is atrocious from Grail's perspective. Grail abandoned plans for an IPO, in very favorable market conditions, to instead be acquired by Illumina. If the company gets spun out now it faces significantly less liquid market conditions.
- Illumina closed the acquisition of Grail on Aug. 18, 2021. The final acquisition price was $8 billion.
- Fellow liquid-biopsy frontrunners Exact Sciences (EXAS) and Guardant Health (GH) boasted market valuations of $16 billion and $10 billion, respectively, on Aug. 18, 2021.
- Grail generated $22 million in first-half 2022 revenue. Exact Sciences and Guardant Health generated revenue of $1 billion and $205 million, respectively, in the first six months of 2022.
- Exact Sciences and Guardant Health are valued at $6.4 billion and $5.2 billion, respectively, as of the market close on Sept. 6, 2022.
Grail would earn a healthy premium as a stand-alone company, but given today's market conditions, it likely would be valued at only a fraction of its acquisition price.
The best option seems to be to head back to the private markets and grab more venture capital as clinical trials wrap up in the coming years. Falling into the wanting arms of a private-equity firm could make sense, too.
The revaluation of Grail also affects Illumina. The company coughed up $3.5 billion in cash and $4.5 billion in shares to close the acquisition. Selling the liquid-biopsy platform in today's market conditions wouldn't come close to recouping costs.
The Bill Always Comes Due
There's not really much for investors to celebrate following the EC ruling. Illumina thumbed its nose at regulators before they could conduct routine reviews of its proposed acquisition of Grail. Now the company and its holders will pay the price.
The divestiture will consume valuable management bandwidth and company resources.
Even if the upcoming spinoff or sale of Grail goes smoothly, the business is likely to incur significant expenses to unwind the acquisition and disentangle operations.
It will be forced to write off billions of dollars in goodwill and intangibles considering the new price tag won't be anywhere near $8 billion.
Simply put, breaching the standstill obligation from the European Commission will likely be remembered as an epic failure by management.