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Illumina's 'Maverick' Move Secures Grail Deal But Risks Loom

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NEW YORK – Acquiring Solexa defined Illumina for the last decade, and the surprise announcement this week that it has closed its acquisition of Grail, despite ongoing antitrust investigations, will likely define it for the next one, whether or not it all pans out in the company's favor.

Various Wall Street analysts have called the move "maverick," "a bold stroke of gamesmanship," or even "premature," but the decision to go ahead with the deal suggests that the San Diego-based sequencing technology company values its new subsidiary at even more than the approximately $8 billion in cash and stock it will ship off to Grail shareholders this week.

Not only do the company's actions risk raising the ire of competition regulators in the US, who are still seeking to block the deal, and in Europe, who are still reviewing it, they could also lead to serious financial penalties.

In a filing with the US Securities and Exchange Commission on Wednesday, Illumina disclosed that the European Commission "will likely seek to impose a fine on Illumina … of up to 10 percent of Illumina’s consolidated annual turnover" — potentially more than $400 million, based on the firm's recent 2021 revenue projections — as a result of Illumina's decision to close the deal while the Commission’s review is still pending.

The European Commission, US Federal Trade Commission, and other governmental or regulatory authorities "may seek to impose other fines, penalties, remedies or restrictions," Illumina wrote, and while the company plans to fight any that may arise, it said it cannot "predict the scope or severity thereof or the outcome of any related proceedings."

Shares of Illumina fell 10 percent in Thursday trading on the Nasdaq, to $459.93.

Outside of mandatory disclosures and disclaimers, Illumina officials downplayed the risks of taking what Cowen analyst Doug Schenkel called "a pretty aggressive approach."

On a conference call Wednesday after making the announcement, Illumina officials hammered at talking points issued in the firm's press release: that the FTC itself removed any impediments to closing the deal in the US, Illumina doesn't believe the European regulators have jurisdiction to review the deal, Illumina will keep Grail completely separate out of "respect" for regulatory processes, and that doing the deal now will save lives.

Illumina CEO Francis deSouza and General Counsel Charles Dadswell used variations of these arguments to respond to most of the more probing analyst questions about the decision to move ahead and close the deal.

For example, when asked whether this might upset the FTC, which withdrew its request for a temporary restraining order in May largely because of the ongoing European investigation, Dadswell said that "when the FTC went into court and asked for the motion to dismiss, that dropped any impediment we had over closing in the US."

Holding Grail separately will allow the European process and the administrative process with the FTC to continue, he added, and "we think we will probably get a decision on the FTC case in the first quarter of next year."

Saving the lives of cancer patients has been Illumina's go-to argument since the FTC first announced in March that it wanted to block the deal, on the grounds that Illumina was the only supplier of next-generation sequencing technology, a key input for early cancer detection tests.

On the call, deSouza put a number on the lives he believes Illumina will save by acting now: 10,000 in the US, over the next decade, and even more in Europe, as the firm plans to eventually bring the test there.

He also said that Grail has not yet sold any tests in Europe and has no immediate plans to do so. "Even if you look at their 10-year plan, they have no firm plans to launch their product into Europe," he said.

Illumina officials also explained that getting the deal done at all meant doing it now. Dadswell said that Illumina does not expect the European Commission's Phase II in-depth investigation, which recently suspended its Nov. 29 deadline, to produce a result until at least the first quarter of 2022. And while the EU's General Court has expedited Illumina's jurisdictional challenge, there is not yet a trial date and the company does not expect a decision for more than a year. Similarly, the company expected the clock to run out before receiving a decision from the administrative law trial at the FTC, which begins next week.

Perhaps Illumina was encouraged by its interactions with the UK's Competition and Markets Authority, which also sought information on the transaction. "Right after we announced the acquisition, we got some initial inquiries from the CMA," Dadswell said. "We started a dialogue with them, went back and forth a couple of times, and they came back to us and said, 'We don't have any further questions about what you guys are doing with Grail.' That was the whole conversation with CMA."

Dadswell also noted that the firm drew up the "hold-separate" agreement between Illumina and Grail based on language from a template provided by the European Commission. Clearing either one of its two hurdles in Europe — the in-depth investigation or the jurisdictional challenge — means overall success, deSouza said.

Whether Illumina has any indication that the FTC will either back down or lose its case remains unclear. Company officials ducked the question when asked on the call, but JP Morgan analyst Tycho Peterson wrote in a research note that company officials later told him "there is a chance that the FTC could drop the process altogether, given a bad history in the courts and what could be a long, drawn-out appeals process."

"We are concerned that there could be unintended and unanticipated consequences with the FTC and other regulators (including heightened scrutiny of future strategic endeavors and possible fees)," Peterson wrote. "That said, the way the company positioned this approach, which surprised us, it seems possible that undoing the transaction, if needed, could be years away."

Should the FTC or European proceedings go unfavorably, deSouza said that the first step would be to pursue all available appeals, a process which could take until 2025 in the US.

If at that point, the company was still required to unwind Wednesday's actions, he suggested that the firm might pursue an IPO, something Grail filed for right before Illumina swooped in.

But several analysts felt the FTC challenge will fail. "This situation reminds us of the $78 billion vertical merger between CVS and Aetna, which was completed in November 2018 but was challenged in District Court for several months," Canaccord Genuity analyst Kyle Mikson wrote, adding that the companies were held separate during a court-ordered review. "Ultimately, the transaction was finalized in September 2019. We recognize that this is not a perfect comparison, but we believe it demonstrates that large vertical mergers can be successfully completed despite lengthy regulatory reviews or opposition."

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