The buzz from day one of the J.P. Morgan Healthcare Conference in San Francisco earlier this week was the announcement on Sunday night by Roche that it was acquiring a majority interest in Foundation Medicine (NASDAQ: FMI) for a bit more than $1 billion in cash, which translates into $50 a share. Those were just the latest eye-popping numbers from Foundation, which went public in September 2013, amid warnings of a biotech bubble. From its initial offering price of $18, Foundation proceeded to enjoy a first-day jump all the way up to $35 a share, straining credulity for those investors focused on the fact that the company had not received meaningful reimbursement for its flagship cancer diagnostic product, FoundationOne.
It’s sixteen months later and Foundation still has not received the positive coverage decisions from Medicare or major private insurers that it would need in order to even dream of making money on its sequence-based diagnostic test. The stock had ridden down to $23 a share before the acquisition and there was plenty of short interest even at that level (pity those investors who did not cover those shorts on Friday!).
But Roche still went ahead and bought the majority of an unprofitable company for $1 billion in a transaction reminiscent of its purchase of a controlling stake in Genentech in 1990. Aside from the deal structures, which in both cases leave the U.S. management team intact—if now reporting to Roche headquarters in Basel, Switzerland—there would seem to be virtually no similarity. Roche has moved far beyond its early-90s status as a small molecule-heavy European pharma eager to transition into biologics. At the time of the initial Roche transaction, Genentech was already a powerful product engine, having developed early protein replacement therapeutics human insulin and human growth hormone with lots more in the pipeline and vibrant science to match. By contrast, Foundation has done little more than make losses on its diagnostics business.
But there is one big parallel between that deal and this one: In both cases, Roche believes that it has seen the future of the pharmaceutical industry. And it can only grasp that future by placing a large and risky bet on a U.S. innovator company. Roche’s thorough transformation into a company invested in targeted therapies driven by disease biology supports my thesis that it was the only pharmaceutical company in the world that had a rationale for acquiring a big stake in Foundation and that it is the one best positioned to make the deal a success.
In my view, the key reasons boil down to these:
• Roche was early and fervent in its embrace of diagnostics as drivers of drug development and sales. I know only one top executive in the pharmaceutical industry who cut his teeth in molecular diagnostics and he did so at Roche—Daniel O’Day, who was the CEO of Roche Molecular Diagnostics from 2006 to 2010 and is currently the chief operating officer of Roche Pharma. Once the Foundation transaction is completed, O’Day and two others chosen by Roche will join Foundation’s board of directors. Aside from the personal, Foundation also fell on fertile ground at Roche on the institutional level. Roche had already changed its drug-discovery focus to be more diagnostics-driven than most other pharmaceutical companies on virtually every level. As Roche CEO Severin Schwan declared in 2012: “More than 60% of our pharmaceutical pipeline projects are coupled with the development of companion diagnostics in order to make treatments more effective.” That number has almost certainly gone up.
• Roche was the pharma that had most thoroughly integrated clinical genomic sequencing into its trial protocols, long before it had figured out how best to use the data. In my work with biotech companies, I had been hearing for years how Roche had embraced sequencing data as a key success factor for the pharma industry of the future. As soon as the cost of sequencing became halfway affordable (maybe $5,000 to $10,000 per full sequence), Roche began to require genomic insights from every patient in every clinical trial. If there was any doubt about how highly Roche regarded sequencing, its $51-a-share Illumina (NASDAQ: ILMN) bid in 2012 dispelled it. (Illumina, whose CEO Jay Flatley said at the time that the bid seriously undervalued his company, now trades at $181 a share).
An executive speaking under condition of anonymity who knows Roche Ventures confirmed that Roche places high importance on genomic data—both that it has itself collected, as well as the data being collected by Foundation. As an aside, Roche Ventures had invested in Foundation two rounds before the IPO in 2012 and had no strings attached in the form of a promised acquisition or partnering deal. That investment is another indicator of the value Roche management placed on keeping up with the world of clinical sequencing. That executive told me on Monday that Roche was counting on Foundation’s data scientists to be able to make the most effective use of their own banks of both sequencing and outcomes data and that the prospect of joining forces was irresistible.
• Roche realized that it would face competition if another pharma company scooped up Foundation. Roche believes that in genomic profiling, it has identified a common theme for creating value in cancer drugs of whatever stripe—targeted therapies like kinase inhibitors; biologics like monoclonal antibodies; and even immuno-oncology approaches like checkpoint inhibitors. Having made this observation, it did not want anyone else to catch up. Combining Roche’s clinical sequencing data and its drug pipeline with Foundation’s gene-level and patient-level insights clearly would realize the most powerful synergy. But in the hands of another pharma, the Foundation team and data sets could have posed competition. Ergo, Roche decided to buy into Foundation now.
• Roche is counting on a shift from biochemical targets to genomic profile targets, especially in drugs for solid tumors. Foundation’s “poster child” cancer cases are those in which genetic profiling suggested—against all experience of oncologists and with no evidence from n-of-1,000 clinical trials—that cancer drug X, developed for, say, ovarian cancer, would work best in cancer indication Y (e.g. prostate cancer). Because the patient is desperate, the physician prescribes the drug and … Next Page »