By Kirell Lakhman

Quest Diagnostics last Thursday said it is “currently considering the potential cash acquisition of a diagnostics testing business.” Since making this disclosure, the reference lab has triggered a spasm of speculation on Wall Street and within the clinical lab space — including test developers and CLIA labs alike — about who it might acquire.

Discussing a half-dozen or so potential targets with several off-the-record chats I had last week with a handful of industry insiders and analysts, one name consistently floated to the top: Vermillion.

Why Vermillion? After all, the shop has had its share of dark days, which some argue descended in December 2005, when it was still called Ciphergen Biosystems. Low on funds — it had just $37.6 million in cash, equivalents, and short-term investments at the time — it was named as a defendant in a class-action lawsuit claiming it and certain of its officers and directors had misled shareholders.

It was also around that time the company was finding that its flagship SELDI mass-spec system was selling poorly because many proteomic laberati believed it was ill-equipped for serious clinical apps. Bruised by floundering sales, the following year, in August 2006, Ciphergen sold the SELDI business to Bio-Rad for $20 million.

These and other factors would eventually lead the company to seek bankruptcy protection, which I’ll touch on below.

In some ways the SELDI divestiture was a wise move because it enabled Ciphergen to focus its resources on uncovering and validating disease-causing biomarkers. The decision would have likely heartened Quest, which was rumored to have secretly encouraged or even orchestrated it from sidelines: Seeing promise in its diagnostic pipeline, the reference lab one year earlier shelled out $15 million for a 17-percent stake in the company.

At the time Quest had no way of knowing it could start seeing a return on its investment in as little as four years. As part of the deal it struck with Ciphergen, Quest would develop a trio of diagnostic tests based on the company’s existing assays. Though neither shop would disclose the indications they would likely chase, a close look at Ciphergen's preferences at the time pointed to its ovarian cancer assay, which CEO Gail Page had called its most advanced product.

In July 2008, exactly three years after Quest bought its stake, Ciphergen, now called Vermillion (it renamed itself in August 2007), added fuel to this supposition by announcing it had hired an investment bank to explore “strategic alternatives” for the test. The bank, ThinkPanmure, a wholly owned US investment banking subsidiary of Panmure Gordon & Co., would help Vermillion identify and evaluate “strategic alternatives intended to enhance the potential” of the multi-analyte test, which had come to be called OVA1, as well as another non-gynecological assay.

In September 2009, two months shy of the 4-year anniversary of Quest’s $15 million gamble, Vermillion announced that the FDA had cleared the OVA1 test, and said the assay would make its clinical debut before the end of 2009.

The in vitro diagnostic multivariate index assay is indicated for women who are aged 18 and older, who have an ovarian adnexal mass for which surgery is planned, and who have not yet been referred to an oncologist. It is based on five well-established biomarkers: transthyretin (TT or prealbumin), apolipoprotein A-1 (Apo A-1), beta2-microglobulin (Beta2M), transferrin (Tfr), and cancer antigen 125 (CA 125 II). OVA1 is also the first FDA-cleared test that can indicate the likelihood of ovarian cancer with high sensitivity ahead of a biopsy or exploratory surgery.

A particularly strong component is a proprietary algorithm designed to determine the likelihood of malignancy in women with a pelvic mass for whom surgery is planned.

Yet some of the excitement surrounding the approval would be overshadowed on March 30 when Vermillion announced it had filed for Chapter 11 bankruptcy protection. The company blamed an inability to raise new capital brought on by the ongoing "global liquidity crisis." In the bankruptcy filing, Vermillion said that as of Sept. 30, 2008 it had approximately $7.2 million in assets and around $32 million in liabilities.

But soon, three bright spots would emerge: First, a bankruptcy judge in August extended to Nov. 25 Vermilion's deadline to present its Chapter 11 reorganization plan, and pushed back to Jan. 24, 2010, the date by which Vermillion can solicit and obtain acceptances of the plan.

Then, on Oct. 20, Quest agreed to provide Vermillion with a so-called debtor-in-possession loan worth up to $1.5 million secured by a lien on “substantially all” of Vermillion's assets.

Lastly, on Nov. 12 Vermillion announced that the US Patent Office has issued it a patent to “for the discovery of biomarkers for ovarian cancer.” According to the company, Patent No. 7,605,003, entitled "Use of biomarkers for detecting ovarian cancer," covers “biomarker combinations for both the diagnosis and management of ovarian cancer and covers measurement of the markers by a variety of methods, including mass spectrometry and immunoassay approaches.”

In a statement, Vermillion said the new IP is meant to “protect our ovarian cancer testing franchise.”

According to one analyst, “the IP surrounding the test is air tight.”

Vermillion Dollar Baby

Saying Quest and Vermillion’s relationship is complex would be a cheerful understatement. And Quest’s repeated attempts to ensure that Vermillion and its OVA1 test stay in the game underscores how strongly the reference lab believes in the test — and not least because LabCorp, its chief rival, has hinted it is considering launching a similar assay.

So what other evidence supports the speculation that Quest intends to use part of its impending $750 million war chest to buy Vermillion outright? According to some insiders there are several reasons.

For starters, Quest has a 3-year exclusive supply agreement with Vermillion that requires it to shell out 5 percent of all revenue generated by sales of the OVA1 test. Also, Vermillion owes Quest $1.5 million from its debtor-in-possession loan.

As one clinical molecular diagnostics veteran put it, with these factors in mind “it would make a lot of sense for Quest to just buy Vermillion outright.”

Then there’s the potential patient population for the test: According to most estimates, the annual market size for the OVA1 test, which Quest would perform, ranges between 1 million and 5 million patients annually.

And then, of course, there’s the extraordinary growth Vermillion’s stock has seen over the past two months. Since the late spring the firm’s shares have been trading in pennies. When OVA1 was approved Sept. 11 the stock jumped 250 percent in a single say. Last Friday it closed at $22.20 — an 18,000-percent increase since the beginning of the year.

Even with this stock surge, buying Vermillion could be affordable and potentially highly profitable for Quest. Vermillion currently has around 7.5 million convertible and outstanding shares, which means the company could be bought for around $166.5 million if using last Friday’s $22.20 closing price. “It makes sense” financially, according to another analyst, who is a managing director of a prominent merchant bank that focuses on biotechnology companies. (He said his bank does not have a position on Quest or Vermillion, though he personally is long on Vermillion stock.)

Another carrot would likely come from the US government, which he said “is currently working on a reimbursement schedule” for OVA1. The government’s verdict, which is expected before the end of the year, could set reimbursement rates at around $65-$70 per test, meaning that the assay could potentially generate at a minimum between $65 million and $325 million in annual revenue.

If Quest makes the buy, it could theoretically pay for it in as little as 2.5 years.

Lastly, the 3-year exclusivity clock starts ticking when Quest launches the assay. “After that Vermillion can sell the test to anyone,” he said. “If Quest is going to buy them now would be the time."

A potential hurdle lies in LabCorp, which has hinted that it still hopes to revive its own short-lived ovarian cancer-risk immunoassay, which interrogates six biomarkers to Vermillion’s five. Indeed, for a short time last year LabCorp was first to market the LDT, called OvaSure, but eventually succumbed to FDA pressure to pull it from the market.

In late September, a LabCorp spokesperson told me the company “will continue to engage in discussions with the FDA” regarding the OvaSure.

LabCorp launched OvaSure in June 2008. The test, co-developed with researchers at Yale University School of Medicine, was designed to assess early-stage ovarian cancer in high-risk women.

Two months later, FDA sent LabCorp a warning letter saying OvaSure was “misbranded” because certain of its parts were not developed by the company, and that it deemed it an IVDMIA, just like the OVA1 — a category that remains in a regulatory purgatory.

In October of that year, LabCorp fought back, saying it would continue marketing the test because it “meets all applicable CLIA regulatory requirements.” But a few days later the reference lab reversed course and pulled OvaSure from the market.

The LabCorp official who spoke with me in September said the company “is still very supportive” of OvaSure, though added it “cannot comment on the regulatory pathway at this time.”

Some believe Quest can beat this challenge because its algorithm enables the OVA1 to be 90-percent accurate. One answer could come from a peer-reviewed study comparing OVA1 and OvaSure head to head. But first LabCorp will have to launch its assay.

Officials for Quest and Vermillion did not immediately respond to requests for comment.