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As CuraGen Mulls 454's Future, Three Options Emerge

NEW YORK (GenomeWeb News) – Ending months of speculation, CuraGen said publicly last week it has begun looking for strategic options for its majority stake in 454 Life Sciences.
 
The company cited as reasons the desire to “ensure funding for our advanced oncology pipeline and ensure that 454 Life Sciences has sufficient resources to support its growth and expansion.”
 
The news was hardly a surprise: Equities analysts had in the past asked about the possibility of spinning off the 454 business, and CuraGen CEO Frank Armstrong, who took over the helm at the drug developer earlier this year, said as early as this spring that he was “looking to see how we get the very best value for CuraGen and our shareholders out of the assets that we have today,” including 454.
 
It is far from clear, though, what CuraGen will eventually decide to do with 454, in which it has a 66-percent stake, or when it plans to do it. “We are prepared to look very broadly with Goldman Sachs as our advisors at a range of possible options for the 454 business,” is all Armstrong said during last week’s second-quarter earnings call in response to an analyst’s question about the strategic alternatives.
 
As it stands now, CuraGen likely has three principal spin-off options, according to people familiar with the sequencing market: CuraGen can either sell the unit outright or spin it off through an initial public offering, both of which could generate significant one-time capital gains; or it could create a tracking stock for 454 that will enable investors to gamble on 454 directly while ensuring that CuraGen maintains the financial support that the company has begun to generate for it.
 
“This is probably a good time for CuraGen to spin off 454 because the next-generation sequencing space is developing rapidly, it’s under way, and Solexa has launched,” said Nate Cornell, an analyst at Pacific Growth Equities who covers Solexa.
 
CuraGen disclosed its intent for 454 at a time when the unit is maturing both financially and scientifically. On the money side, for the three months ended June 30, 454 booked $9.8 million in revenues, which amounted to 92 percent of CuraGen’s total take in the quarter and were almost three times as much as it posted during the same period last year. Of that amount, $5.4 million came from instrument and reagent sales, $2.3 million was from sequencing service revenues, and $2.1 million was from grants and other sources.
 
Although 454 did not disclose the number of Genome Sequencer 20s it sold during the quarter, based on last year’s numbers, it likely booked approximately 9 units –– almost half the total it sold during all of last year.
 
CuraGen said it expects 454 to generate between $30 million and $35 million in revenues for the year and burn between $7 million and $15 million in cash this year.
 
454’s visibility in the scientific community has been building, too, thanks to a string of peer-reviewed papers published during the quarter showing how the GS20 can be used for a variety of applications, including oncogene sequencing and small RNA analysis.
 
454 has also caught the attention of the general public after mainstream media reported its plan to sequence the Neandertal genome with the Max Planck Institute for Evolutionary Anthropology in Germany.
 
On the other hand, 454 has not yet seen much head-to-head competition -- though this is likely to change soon. Its closest competitor, Solexa, in late June shipped its first instruments to early-access customers and said it will release the commercial version of its machine later this year.  
 
Technically, 454 is working to improve its platform: a paired-end sequencing protocol, along with other new applications, is “now in the hands of early-access collaborators as we prepare with our distribution partner, Roche Applied Science, for a general market launch,” said 454 CEO Chris McLeod, during last week’s earnings call.
 
Options
 
One option for CuraGen would be to divest 454. This could generate a one-time windfall for CuraGen -- and as an emerging drug maker the company needs all the capital it can get: CuraGen this spring said it has at least two years of cash available to fund its operations. As of June 30 it had $124.5 million in working capital and it expects to burn through between $32 million and $37 million in cash by the end of the year.
 
One obvious candidate is Roche Diagnostics, whose Applied Science business unit is currently 454’s exclusive marketing and distribution partner. Under Roche’s 5-year agreement with 454, signed in May 2005, Roche has the right to renew the agreement and to negotiate to distribute 454’s products in the regulated diagnostic market.
 
Roche, the dominant player in that market, might decide that it would be easier to purchase 454 outright. A spokesman for Roche told GenomeWeb News that “we assume that our collaboration with 454 will not be changed by CuraGen’s considerations.”
 
Other possible purchasers might be companies like GE Healthcare or “non-traditional life science tools companies” such as Siemens Medical Solutions, according to Richard Fisler, president of Beachhead Consulting, which advises life science tool companies.
 
GE Healthcare has said on several occasions that it plans to integrate its imaging technologies with molecular diagnostic platforms as part of an “in vivo/in vitro” diagnostic offering, while Siemens in June said it plans to acquire Bayer Diagnostics in an effort to play in the molecular diagnostics market. Siemens also just completed its acquisition of Diagnostic Products last week.
 
Fisler, a former 454 official, said companies like these will have sufficient cash to pay for an acquisition. Fisler said he no longer has ties to 454 and does not currently consult for a DNA sequencing firm.
 
A spokesman for Siemens Medical Solutions said the company does not speculate on any future business plans. GE Healthcare was unavailable for comment before deadline.
 
However, being acquired might limit 454’s options to develop the way it wants. “You always want to control your own destiny if you can by raising money,” said Fisler. “As soon as you turn over to a new partner, that partner has its own goals. [These] may also be great, but they may be more narrowly focused.”
 
Another option for CuraGen might be to take 454 public. This could also generate a one-time windfall for CuraGen.
 
But “the market situation right now for IPOs in this space is not very favorable,” said Fisler. “Part of this is that sequencing is a commodity, and until you can show that this new brand of sequencing significantly impacts the customers’ business – be it drug development, vaccine development, discovery, or the government’s cancer genome project -- an IPO now may not be as successful as it could be,” he added.
 
Indeed, just last week another research technology provider, Caprion Pharmaceuticals, said it has withdrawn its IPO due to “adverse market conditions.” Caprion provides proteomics technology to profile proteins in tissues and plasma.
 
A third option would be to turn 454 into a standalone tracking stock subsidiary, like CombiMatrix, which belongs to Acacia Technologies but trades under its own ticker symbol, or Applera’s Applied Biosystems and Celera Genomics groups, which have their own stocks.
 
From an investor’s point of view, these last two options might be most favorable. “A lot of shareholders want CuraGen to unlock the value of 454,” said Cornell, the Solexa analyst. “If I were an investor, I would like to see it trade independently, not being acquired.” This would allow investors “to have a pure-play investment in the company, so you are buying 454 without owning CuraGen’s drug-development business.”
 
So how much is 454 likely worth, either to an investor or to a suitor? The company could have “considerable value if you consider what Agencourt got from ABI,” according to Fisler. ABI bought Agencourt, which is still far from gaining revenue from its system, for $120 million.
 
“CuraGen should be able to say that, because they have a revenue-generating system both in sales of instruments and services they could generate a higher return than an Agencourt, assuming -- and the big assumption here is -- that they can perform technically at the level they need in order to do higher-organism sequencing … and not just filling in gaps. Not just a supplement to Sanger sequencing,” Fisler said. “If CuraGen wants to maximize its return, they need to show that [its system] can do the widest breadth of applications possible [on higher order organisms].”

  

Julia Karow covers the next-generation genome-sequencing market for GenomeWeb News. E-mail her at [email protected].

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