The Health Care M&A Monthly: Spotlight On Diagnostics–

Dealmakers Targeting Diagnostic Testing Businesses
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Deals announced in several different sectors of the health care industry this month revealed an interest in acquiring diagnostic businesses to further a variety of goals. As fans of the TV show House know, the quick, accurate diagnosis of a patient’s disease or disorder is a prerequisite to prescribing an efficient course of treatment. And physicians rely heavily on diagnostic tests. January’s first-, third- and fifth-largest health care deals all involve one facet or other of the diagnostic testing business.
After several months of wooing and then plumping up its initial offer, Roche Holding (SWX: ROCZ.S) finally persuaded Ventana Medical Systems (NASDAQ: VMSI) to be acquired. Readers will recall that Roche first approached Ventana in late June 2007 when it offered to pay $75.00 per share to buy the company, which at that time offered VMSI shareholders a 45% premium to the stock’s prior-day trading price. Ventana’s board recommended against the offer as being underpriced; the market concurred by kicking the stock’s price into a trading range of $77.00 to $78.00 per share, effectively turning Roche’s premium into a discount. After six months of serious negotiation, VMSI agreed to an enhanced offer of $89.50 per share in cash, one unlikely to be bettered in the current environment.
Based in Tucson, Arizona, Ventana develops, manufactures and markets diagnostic systems, specializing in histopathology. It is focused on instrument-reagent systems that automate slide staining in anatomical pathology and drug discovery laboratories. The company’s clinical systems are used in anatomical pathology labs for analyzing human tissue to assist in the diagnosis and treatment of cancer and infectious diseases. Its drug discovery systems are also used by pharma and biotech companies to improve the discovery of new drug targets and to evaluate the safety of new drug compounds. On a trailing 12-month basis, VMSI generated revenue of $278.0 million, EBITDA of $66.0 million and net income of $37.0 million.
This new bid offers Ventana shareholders a 19.3% premium to ROCZ’s initial offer made on June 27, 2007, a 4.9% premium to the stock’s prior-day price on January 21, 2008 and a 72.3% premium to its closing price on June 22, 2007, the last trading day before ROCZ made its initial offer. The most current offer is valued at approximately 12x revenue and 52x EBITDA. What, you may ask, is Roche’s incentive for paying such lofty multiples?
First, VMSI’s strong position in histopathology, particularly in the area of cancer, complements ROCZ’s own leadership position in in vitro diagnostic systems and oncology therapies. Tests and therapies for cancer are among the most expensive medical procedures around; hence, among the most profitable. Second, this acquisition allows Roche to build up its diagnostic offerings, which currently account for 20% of the company’s revenue. This enhances Roche’s ability to package diagnostic tests for various diseases and disorders alongside the treatments for those conditions, and provide physicians and customers with one-stop shopping. Third and looking to the future, this deal better prepares Roche to capitalize on the much-touted aim to provide personalized medicine, in which patient-specific diagnostic testing is a critical component.
Inverness Medical Innovations (AMEX: IMA), the single most prolific acquirer of 2007, announced its acquisition of Matria Healthcare (NASDAQ: MATR) for $39.00 per share. Inverness Medical has three segments: consumer diagnostic products, vitamins and nutritional supplements, and professional diagnostic products. On a trailing 12-month basis, it generated revenue of $601.0 million, EBITDA of $86.0 million and a net loss of $7.9 million. Not only is IMA deeply involved in producing diagnostic tests, it also wants to acquire the channels through which these tests are distributed, which explains its recent interest in, and acquisition of, disease management companies. In recent months, IMA has acquired two disease management companies; ParadigmHealth for $230.0 million, Alere Medical for $302.0 million. These companies contract to monitor (diagnose) and control (medicate) large populations of patients with specific chronic diseases, such as diabetes, who use diagnostic tests, and use them frequently.
Marietta, Georgia-based Matria Healthcare provides integrated programs and services focused on wellness, disease and condition management, and informatics. It generates revenue of $352.2 million, EBITDA of $76.3 million and net income of $21.5 million. Once an avid acquirer, early in January, MATR announced it was exploring strategic alternatives when it hired The Maren Group LLC and Sun Trust Robinson Humphrey as advisers to begin mulling over the sale of the company. IMA appeared on the scene as a suitor in just two weeks.
Under terms of the deal, IMA will pay $39.00 per share, which is payable in $6.50 in cash and $32.50 in convertible preferred stock. Rounding out the deal is the assumption of $280.0 million in debt, which raises the total purchase price to $1.18 billion. This deal, valued at 3.4x revenue and 15.5x EBITDA, offers MATR shareholders a 27% premium over the stock’s prior-day price.
This acquisition accelerates IMA’s recent entry into the disease management industry as a means of securing a ready outlet for its point-of-care diagnostic testing products. What MATR brings to the table is a portfolio of contracts with over 1,000 employers and managed care organizations; hence, a “captive” customer base for all those tests. Not forgetting its primary (so far) testing business, IMA also made a second, smaller deal (we assume since there was no price) in January. It acquired a license from BioCurex (OTCBB: BOCX) for the company’s RECAF technology, which utilizes a wide-spectrum marker to detect malignant cancer cells. This gives IMA semi-exclusive global rights to commercialize products using BOCX’s technology; the marker is thought to be highly sensitive and specific in detecting various kinds of cancer even at early stages, which would give it a clear competitive advantage over other drugs. Terms stipulate upfront fees, annual minimum royalties and royalties on product sales.
In the biotechnology arena, Abbott Laboratories (NYSE: ABT) acquired an equity interest in Ibis Biosciences from Isis Pharmaceutical (NASDAQ: ISIS), along with an option to acquire the biotech’s subsidiary. ISIS is selling an interest in its Ibis Biosciences subsidiary, which is developing the Ibis T5000 Biosenor System. This system allows for the rapid identification of infectious agents in a sample without prior knowledge of what may actually be in the sample. Commercialization of this product will target areas in health care and beyond, including biodefense, forensics, epidemiological surveillance, infectious disease research and hospital-associated infection control. For example, one such system was delivered to Homeland Security in 2007.
Under terms of the deal, ABT’s Abbott Molecular subsidiary is to pay $20.0 million for 10.25% of Ibis; it also has the right to invest an additional $20.0 million before July 31, 2008 for a total 18.6% of Ibis’ equity. The terms also grant ABT an option to purchase the remaining equity of Ibis for an additional $175.0 million to $195.0 million through June 30, 2009. In theory, this deal enhances ABT’s diagnostics business by giving it access to a test that can rapidly identify and characterize virtually all bacteria, viruses and fungi, as well as provide information about drug resistance, virulence and strain type, within a just few hours. ABT could further capitalize on such an acquisition by retaining health care applications while out-licensing the system in other areas, say biodefense.
This is the most recent collaboration that ISIS has undertaken with its proprietary technology. Earlier in the month, the company licensed rights to Genzyme Corp. (NASDAQ: GENZ) to develop and commercialize Mipomersen, a drug candidate to treat familial hypercholesterolemia (FH) in a deal potentially worth $1.9 billion, which makes it January’s second-largest transaction. Patients with FH have high concentrations of LDL cholesterol due to a genetic disorder.
Under terms of the deal, ISIS is to make initial payments of $325.0 million; $825.0 million in developmental and regulatory milestones; and $750.0 million in commercial milestones. Profit-sharing on net drug sales is also stipulated in the agreement. The profit sharing begins with a 70/30 GENZ/ISIS split and reaches 50/50 on a sliding scale as annual revenue ramps up to $2.0 billion.
This deal gives GENZ access to a new lipid-lowering drug for use primarily on patients with FH, but which may also be indicated for patients who are intolerant of statins, the most common class of cholesterol-lowering drugs, or who cannot achieve target levels with statins alone. As it is an injectable drug, it will likely not compete directly with such oral medications as industry leader Lipitor.
However, it is the underlying antisense technology, which manipulates genetic material, that is scientifically interesting, and holds out the ultimate promise of “personalized medicine” based on a patient’s genetic profile. The technology uses RNA interference, hence RNAi, to block the formation of specific proteins that are associated with a disease or disorder. The real trick lies in the targeting. The best candidates for antisense technology are probably viruses since the goal of the therapy is to eliminate all tokens of a foreign virus from the patient’s systems by disrupting productions of a virus’ proteins. But treating diseases or disorders that involve malfunctions within a patient’s own cells requires considerable technical finesse: the RNAi mechanism needs to be restricted to very specific targets so it does not turn off the production of the protein in all cells, the majority of which may be healthy. ISIS’ promising drug candidate for FH represents something of an intermediate stage between the two, where the specific disorder has a genetic basis.
This technology thus establishes a very close link between diagnosing the genetic basis of a disease and crafting a potential treatment for it. Once the genetic component of a disease or disorder can be identified, thanks in large part to the human genome project, an oligonucleotide can be synthesized to block the production of the unwanted protein. Here, the diagnostic test directly anticipates the therapy, but can still be used independently of any therapy that may be developed. This approach to drug discovery tends to be much more efficient than the discovery of more conventional molecules, and the drugs developed this way can theoretically address the disease in earlier stages of its development than conventional drugs. This could easily translate into lower R&D costs. A number of drug makers have been persuaded by this logic: ISIS and its partners currently have 17 drugs in development, some in Phase I or II clinical trials. ISIS appears willing to sell off its Ibis diagnostics subsidiary to help finance its core RNAi antisense drug development initiatives.
Earlier in September 2007, ISIS entered into a collaboration agreement worth up to $275.0 million with Johnson & Johnson (NYSE: JNJ) to develop two molecules, ISIS 325568 and ISIS 377131, for the treatment of metabolic diseases. JNJ subsidiary Ortho-McNeil acquired these two RNA antisense molecules for the potential treatment of diabetes and obesity. ISIS, in turn, used the proceeds to regain full ownership of its lipid-lowering drug ISIS 301012, its most promising drug candidate.
In May 2007, Isis had licensed an early-stage cholesterol drug to Bristol-Myers Squibb (NYSE: BMY) for up to $192.0 million. Isis has shown that reducing PCSK9 in mice leads to increased levels of LDL receptor and, consequently, to lower “bad cholesterol” in the blood stream; it thus held out promise for the prevention of coronary artery disease. In the space of just seven months, however, ISIS was able to procure for itself a deal with GENZ worth 10 times the BMY deal.
We are perhaps still a long way off from Dr. McCoy’s medical tricorder, but investors are looking at the scientific and business potential of ISIS’ diagnostic testing technology, and they are betting that it’s getting closer.
 
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