Illumina is the dominant player in the high-speed gene sequencing business, and has been for a number of years. That powerful position in a field that’s vital to the future of healthcare has made it the object of intense scrutiny, and in some cases, scorn, from customers, competitors, and potential acquirers.
Last year, the big event came when the San Diego-based instrument maker (NASDAQ: ILMN) fought off a $6.7 billion hostile takeover bid from Switzerland-based Roche, saying in essence that it could be a lot more valuable on its own. Many of its actions since could be interpreted as the moves of a hunter, not a company that sees itself as prey.
After the dust settled last spring in the Roche takeover battle, Illumina bought a couple of diagnostics companies, BlueGnome and Verinata Health, to follow through on its stated plan to morph into a more diversified maker of research tools and genomic diagnostic tests. The company has been racing to fend off rivals in the sequencing business like Carlsbad, CA-based Life Technologies (NASDAQ: LIFE), and smaller players such as U.K.-based Oxford Nanopore that pose technological threats to its platform for DNA sequencing. Illumina has ruffled more than a few feathers in the industry with some aggressive moves, including an unsuccessful bid to stop BGI-Shenzhen from acquiring Mountain View, CA-based Complete Genomics (NASDAQ: GNOM).
I met with Illumina CEO Jay Flatley to discuss all of these issues and more during a wide-ranging interview last Tuesday (January 8th) at the JP Morgan Healthcare Conference in San Francisco. Here are excerpts of the conversation, edited for length and clarity.
Xconomy: You have been one of the busiest newsmakers in the industry lately. You bought Verinata Health, then another company, Moleculo, a spinout from Stanford University. You pre-announced fourth quarter revenues of $309 million that were higher than consensus expectations on Wall Street. You reportedly said no to another recent acquisition inquiry from Roche. What else is up your sleeve for this year?
Jay Flatley: We have a lot going on, we’re busy fellows. We have a pretty rich pipeline of opportunities that come our way now, because of the size we are and the presence we have in the market. We get to look at lots of different companies. It’s driven in part by the challenges in the life sciences venture capital industry. Some are getting out of the business. Sometimes small companies get to the first step in development, and they are looking for strategic partners, or for somebody to buy them out. So we get to look at a lot of things. We don’t do that many. We do a handful of tuck-ins per year, and occasionally a big one like Verinata.
X: How has your strategy around acquisitions changed after the whole Roche thing ended last spring? Do you see yourselves increasingly as the acquirer, rather than the acquired?
JF: Our M&A strategy changed a bit a few years ago, and Roche didn’t particularly influence any change. We used to be more opportunistic—if something came to us and looked interesting, we’d look at it. Now we’re much more proactive. We have a full-time staff that does nothing but this, scouring the States and the world for good licensing opportunities, or good companies that we think we ought to own.
X: What kinds of things are you most interested in now? Diagnostic companies, or new technologies to build up the platform?
JF: It spans a wide range. We’re clearly looking at diagnostics, we’ve been very public about that the past couple of years. We’re looking for something to really enhance our penetration in diagnostics, more rapidly than we could organically. Verinata certainly does that. We’ve looked across the entire space. There frankly aren’t that many high-quality assets that can move the needle for us, and we think Verinata can.
We’re always looking for good technology pieces, and Moleculo is a great example. It’s a company that’s young and small, but they have a great technology that will help inch our product line forward in some interesting ways. We are always looking for interesting assay methods out there. Software is an area we have been looking.
X: Do you worry about how getting aggressive in M&A might backfire? There has been some commentary made about you guys moving to compete against Sequenom (NASDAQ: SQNM) in the prenatal genetic testing market. These guys, I believe, are your No. 1 customer.
JF: They are a very important customer to us. The goal here certainly isn’t to compete directly with Sequenom. One of the things we’ve tried to make very clear—and we talked to them before we announced this—is that our goal is to make the whole field expand and continue to have them be a strong customer for us. There are couple components to this. One is that we think Verinata has the foundational IP in the field, and we think the field is being held back a little bit by IP overhang. There may be a way now that we can work that out. I’d like to see if that’s possible.
We clearly have a partnering strategy to take this technology to the market. We’d love to partner this (Verinata Health’s prenatal genetic test). Part of what we’ve done here is in recognition of the fact that in five years, this is going to be an IVD (in vitro diagnostic) market. People will want an FDA-approved test they can run in lots of labs. While the technology was split up, with assays being in other companies, and us having the platform, there was no really easy way to get an application through the FDA. We’d love to work with all these companies. We want to help Sequenom, help Ariosa (Diagnostics) and further our business as well.
X: What other kinds of diagnostics are you looking to tuck in?
JF: We’ve been very active in the cancer field, but these are not things we think are going to be acquisitions. They are tools we put out on the market. For example, we put out a somatic cancer panel. It’s to help accelerate CLIA (centralized clinical labs). They can add additional content on top of this. But it’s to get these labs to begin to do cancer vs. normal tissue screening. It’s not that likely we’re going to have a material acquisition in cancer anytime soon. But we’re continuing to watch the field. We have a lot of customers. It’s a very big market with lots of indications. I don’t think there’s any risk of us competing with our customers in cancer.
X: What about technology acquisitions? Moleculo is one of those. They’ll enable you to do more long-read DNA sequence lengths, right? Others, like PacBio, have tried to push ahead on that front to gain an advantage. What’s your rationale for that acquisition?
JF: The great thing about the Moleculo technology is that in order to get long reads, you don’t have to sacrifice throughput or cost. That’s the problem with the other systems. You sacrifice accuracy, with, say, [Oxford] Nanopore’s technology or PacBio. Here we get the accuracy of SBS (sequencing by synthesis) chemistry, plus the long reads. The incremental amount of (extra) sequencing you have to do is very small. It’s about one extra lane on a HiSeq machine to get a full human genome.
It opens up about 10 percent of the next-generation sequencing market that we think really wants long reads. It’s for areas like structural variations in cancer, or de novo sequencing—particularly in complex plant genomes. There are applications like meta-genomics, where you’re sequencing a complex soup of things, when you’re looking at a number of different organisms present, and you’re trying to ask, is this organism present? Having a couple hundred base reads sometimes isn’t enough to figure that out. Certainly there are some clinical applications, in being able to determine whether you’re dealing with a mutation in a gene, or whether it’s from the paternal or maternal strand, can make a big difference in the diagnosis.
Over time, this will be a standard part of what we do. There is some inherent improvement in accuracy when you move to long reads.
X: Are you really going to be able to get reads that go all the way up to 10,000 bases of DNA?
JF: Just the data they have already hits that. The chart I showed today, the maximum read length was 13,000, the average read length was 7-8,000 base range. We actually have an internal program where we can get up to 100,000 base reads. These are synthetic, so to be clear, these aren’t actually using SBS chemistry to read 10,000 bases in a row. It’s labeling the ends of short reads, and then reconstructing them afterwards. So we call it a synthetic long read. But the accuracy is astounding.
X: Why did you say no to Roche’s overtures again?
JF: We said no to Roche at our annual meeting in April, and that’s the last comment we made on Roche.
X: Yes, but they made some recent overture that was reported…
JF: There’s been a bunch of stuff reported in the press, but we didn’t comment on it.
X: So why remain an independent Illumina? Why does that make sense for the company and its shareholders?
JF: We’re certainly not wedded to that notion. We’ve said that openly. This was a matter of having a fair price, and a price that we think puts an end to the upside our shareholders enjoy. To truncate that value at some fixed number requires a number that’s materially bigger than any number we’ve seen. When you look at $51, we were trading at $55 just a few weeks ago. A $51 per share offer just wasn’t in the ballpark.
X: When you look at the markets you can enter, how big do you think the opportunity is, and what kind of share price does that justify?
JF: The markets for sequencing are going to be enormous. Many, many, many billions of dollars when you look out 5-8 years from now. The cancer market will be enormous. The newborn screening market is going to be enormous. If you look just at NIPT (non-invasive prenatal genetic testing) alone, today there’s a $1 billion of value just in doing amniocentesis. This is going to be much bigger than that, because it will be done by more women in the high-risk group who avoid amnio because of the risk to the fetus (potential miscarriages). And it will expand into low-risk pregnancies, because this is a test you can do with virtually zero risk. That market alone has multiple billions of potential.
X: And you think Verinata has the IP advantage in a four-way dispute (with Sequenom, Ariosa Diagnostics, and Natera) the other entrants?
JF: We think so. Nobody’s certain about that until you get to the end of the process, but there’s a chance we can make something work here with the other players.
X: Why did you guys oppose the Complete Genomics merger with BGI-Shenzhen (for $118 million)?
JF: Oppose is maybe…we asked that CFIUS (Committee on Foreign Investment in the United States) get involved, and they did. We think BGI owning it has national security implications, and we thought it was bad that they’d get it. To our surprise, CFIUS let it go through. Yesterday, the Federal Trade Commission approved it too, so we withdrew our bid today (Tuesday Jan. 8).
X: Why is it bad for national security?
JF: Because we think there’s risk they could build very large databases, and get access to the genomes of lots of Americans. They could bring them back to China. There are lots of nefarious ways you could use the information. There are theoretical bad things you could do with those kind of databases if they aren’t regulated by the law of the United States. So we were concerned about BGI’s affliation with the Chinese government. We’ll have to see how it plays out.
X: Isn’t BGI one of Illumina’s biggest customers? They have bought a ton of your HiSeqs.
JF: Yes, they are a very significant customer of ours. We want to maintain a great relationship with them. But we’re not sure it’s in the U.S. national interest to sell the formula for Coke. It’s different when people just buy Coke.
X: Has there been tension in the relationship with BGI since you took this action?
JF: Until this sorted out, in terms of who was going to make the Complete Genomics acquisition, we haven’t had a lot of interaction with them. But I’m certain now that it looks like we know how it’s going to go, we’ll get re-engaged with them and have open discussions about how we can move the relationship forward.
X: How do you think you’re doing vis-à-vis the competition? It’s an extraordinarily competitive field, with Life Technologies, Complete Genomics, PacBio, Oxford Nanopore and others.
JF: I think we’re doing well. We just pre-announced $309 million in revenue in the fourth quarter, which was a record quarter for us. We think we’re continuing to add significant market share against our competitors. We take them seriously and think they are strong competitors.
X: Do you think Illumina still has the edge, technology-wise?
JF: Yes. We have a very rich pipeline of new products. We’re fortunate enough now to be big enough that we can invest in a broad way to improve things like sample prep, and bioinformatics. It’s not just for the sequencers. It’s enabled us to introduce new products like Basespace, which we think is a very important cloud-based add-on to our sequencing ecosystem.
X: I want to come back for a bit to the diagnostics world for a minute. I’ve heard some rumblings this week about people being unhappy with Illumina moving into this area, and trying to take over the world. I’ve heard about some moves to jack up prices of reagents for diagnostics company customers. They seem threatened. Are you threatening a lot of your customers, who are aspiring molecular diagnostics companies?
JF: Not at all. We do think in the diagnostics market, the requirements those companies appropriately place on us, in terms of having different products, better lot tracking, keeping longer inventories, giving them advance notice of changes—it all requires us to build a different infrastructure inside the company, a parallel infrastructure. That’s expensive for us. We’re putting all those capabilities and systems and duplicate part numbers in place. As a result of that, we think premium pricing is justified for diagnostic kits.
X: So there was a recent price increase for diagnostic customers, compared with standard academic research labs?
JF: Pricing for our RUO (research use only) kit is different than for diagnostic customers. They are separate market segments. The diagnostic group does their pricing based on whatever the cost is of the infrastructure.
X: But was there a price increase recently?
JF: Don’t think of it like that. It’s not like it was some price one day and it changed. It wasn’t an increase. But we’re starting to have new products we put in the market that have different capability. They have different packaging, different lot tracking, different shelf life, different notification and supply agreements. They are priced appropriately.
X: So these customers have a different set of needs, and they are paying more?
JF: Exactly. And if they want to keep using our RUO reagents, they can continue to do that. We aren’t forcing them to take those new products.
X: What worries you the most when you look at the business landscape?
JF: In 2012, (federal budget) sequestration was clearly the biggest worry we had. It caused a lot of uncertainty in the business, and we didn’t know how customers would respond to it. We’ve come out of 2012 with much less impact than we might have anticipated. That’s probably less of a worry for us now. Now, it’s probably just tracking what the competition is doing, and making sure we are in the market with products that as are competitive as we can make them.
X: What’s the biggest problem your customers are facing, that you need to solve?
JF: It probably relates to interpretation of genomes. We’ve had great work done on the core sequencing engine, and made a lot of progress on sample prep. On the front end couple pieces of software, we’ve made lots of progress there, in terms of reducing file sizes and aligning genomes and call variants. Now the problems are moving into things like what the genome means, and what the variants mean. A lot of academic world is focused there, and we’re trying to help. Particularly around cancer.
X: Did you actually hit the $1,000 genome threshold by the end of 2012? I know that both you and Life Technologies, if memory serves, said at this meeting (JP Morgan Healthcare Conference) last year that you’d be able to sequence an entire human genome in one day for $1,000.
JF: That’s not quite accurate. What happened exactly a year ago at this meeting is that two companies announced they would have ability to sequence a complete human genome in a day. One company said they could do it for $1,000, and that was Life Technologies. We never put any pricing out in the market, but we said we could do the sequencing in a day. In February, we presented the first data on that. In the second quarter, we deployed the technology in our services operation. In the third quarter, we put it in the hands of customers. In the fourth quarter, we shipped it in volume. We delivered exactly on the program we promised.
X: So what does it cost now to do a whole genome, just the sequencing, on a HiSeq?
JF: It varies, depending on the volume of the customer. The discounts can vary, depending on what their usage rates are. If you look at the range of numbers, if you look at instrument depreciation and reagent costs, it varies from a couple thousand dollars up to $5,000. It depends also on what mode you run the instrument in, too. It’s a bit more expensive to run the instrument in rapid mode than in high-throughput mode.
X: How do you stack up on cost with Life Technologies at this point?
JF: We’re very competitive. Right now at least, they’re not doing whole human genomes.
X: With the SOLiD or the Ion Torrent?
JF: The SOLiD isn’t much of a factor in the market anymore. With Ion Torrent, to our knowledge, they aren’t at the output levels people will use for human genomes.
X: It’s more about targeted, regional sequencing, right?
X: Personally, this had to be a very intense year for you. How do you feel about what you’re doing. Triumphant? Vindicated? Do you feel good about what you’re doing?
JF: I’ve never been more optimistic about the company and the markets we’re in. I feel very good about how the technology stacks up right now. We’ve got a great management team, and a great overall team. It’s a lot of fun to do what we do. It was an intense year from a workload perspective. Particularly in that Roche (hostile takeover bid) window, there were three or four weeks when we did not much else. But after that was over, we spent our time doing the blocking and tackling it takes to run a business and produce more innovation.
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