Does Roche Have It Right?

Roche's hostile tender offer for Ventana Medical Systems, and to a lesser extent its recent acquisitions of life science tools companies this year, highlight the firm's belief in diagnostics and its bet that personalized medicine--an area where innovative platforms and molecular test content will play significant if separate roles--will be key to its long-term growth. It could be an expensive and risky strategy that will take years to come to fruition.

Acquisitions could help to lay the groundwork for a long-term plan in personalized medicine and the development of drugs and companion diagnostics

Mark L. Ratner

The business development team in diagnostics at Roche has been busy lately, both on its own and tracking its competitors’ moves. In late June, Roche made a $3 billion hostile tender offer for anatomic pathology company Ventana Medical Systems Inc. [See Deal] It’s also acquired several life-science tool companies in 2007 at a cost of just over $1 billion. These recent acquisitions highlight Roche’s belief in its diagnostics business and the company’s bet that personalized medicine--an area where innovative diagnostics platforms and molecular test content will play significant if separate roles—will be key to its overall long-term growth.

Through its diagnostic segments Roche has dedicated itself to the in-house development of companion tests—a hallmark of personalized medicine and a strategy that distinguishes it from most other Big Pharmas. Indeed, few large drug companies also maintain diagnostics businesses of any kind. But diagnostics isn’t exactly a booming business at Roche at the moment. Outside of its diabetes testing franchise, which because of its primary care, consumer-oriented focus serves a much different market than do its other diagnostics plays, Roche’s segments in applied science (life-science research tools), molecular diagnostics (nucleic acid–based testing), and professional diagnostics (immunoassay, chemistry, and other central lab–oriented tests) are exhibiting mid-single-digit growth. The Roche Group has the free cash to invest in building up those businesses, and it is clearly aiming at personalized medicine as a principal way to bolster them long term--and importantly, also support the development of targeted drugs on its pharmaceutical side.

But this could be an expensive and risky strategy for Roche that will take years to come to fruition. It will also be difficult to manage investors, who focus on quarterly earnings numbers and expect pharmaceutical-like growth, along the way as it waits for the science and the business to pan out.

There’s been lots of acquisition activity in diagnostics recently. Inverness Medical Innovations Inc. outbid Beckman Coulter Inc. for Biosite Inc. [See Deal] [See Deal] (See "Wake-up Calls in IVD," IN VIVO, April 2007 [A#2007800055].) A year ago, Becton Dickinson & Co., which already held a 6.5% stake in TriPath Imaging Inc., a smaller competitor to Ventana in the area of tissue-based cancer tests, acquired the remainder of TriPath for $350 million [See Deal], and B-D also picked up nucleic acid–based infectious disease testing company GeneOhm Sciences Inc. in January 2006 for $230 million cash. [See Deal] In immunoassays (IA), the GE Healthcare division of General Electric Co. announced its intention to buy Abbott Laboratories Inc. ’s core lab diagnostics and point-of-care testing businesses for $8.13 billion in January [See Deal], and has been eying molecular diagnostics since its $9.4 billion purchase of Amersham PLC (now GE Healthcare Bio-Sciences Inc.) in 2003. [See Deal] (See "GE Grabs the Spotlight in IVD," IN VIVO, March 2007. (Also see "GE Grabs the Spotlight in IVD" - In Vivo, 1 Mar, 2007.)) The Abbott deal fell through in early July, but Siemens AG grabbed both Bayer Diagnostics and immunoassay player Diagnostic Products Corp. last year, for $5.3 billion and $1.86 billion, respectively. [See Deal] [See Deal] (See "Siemens Acquires Bayer Diagnostics, Creates Integrated Diagnostics Powerhouse," IN VIVO, July 2006 and "In Vivo and In Vitro Diagnostics Converge: Siemens Buys DPC," IN VIVO, May 2006. (Also see "Siemens acquires Bayer Diagnostics, Creates Integrated Diagnostics Powerhouse " - In Vivo, 1 Jul, 2006.) (Also see "In Vivo and In Vitro Diagnostics Converge: Siemens buys DPC " - In Vivo, 1 May, 2006.))

This landgrab mentality may be one of the reasons for Roche’s hostile bid for Ventana. Roche CFO Erich Hunziker alluded to the current market dynamic several times in the conference call during which he discussed his firm’s desire to go after Ventana, which did not field Roche’s calls and whose management and board of directors have told shareholders to roundly reject the deal.

"You may ask why Roche sees a certain urgency for this deal," Hunziker proposed early in the call. "Leaving Ventana’s successful team unchanged and giving them the support of a global company could be very crucial at a time when key competitors in this market are still aligning their efforts after having just been taken over," he declared. He was likely referring directly to B-D with TriPath, and possibly indirectly to Biosite and the IA players, including Abbott. "Maybe this reflects the climate more in the diagnostics field than in pharmaceuticals, where traditional licensing deals can be done to bring innovation into our Group," he said. The scarcity of molecular diagnostics content is one reason for the high premiums offered companies like Biosite (63%, measured from the time of Beckman Coulter’s initial offer), TriPath (58%), and Ventana (43% at the time of Roche’s initial tender price of $75 per share). An exit via acquisition is nearly impossible to resist at these prices, leading to a wave of consolidation in diagnostics that only seems to be picking up steam.

Coordinating Diagnostics with Drug Development

On the one hand, Roche clearly wants to jump-start growth in its diagnostics businesses, and sees competitors lining up for faster-growing assets. "Five to six percent in the core lab is about average," notes Bruce Cranna, analyst with Leerink Swann & Co. "But most people would tell you, as would I, that in molecular diagnostics [which at Roche grew at a similar clip in the first quarter of 2007], that’s lagging."

Its strategy with Ventana is broader than a short-term fix, however. In addition to buying a leading company in a billion-dollar histopathology market that’s growing at 10% per year, Roche wants Ventana for strategic reasons relating to its drug business. The deal "is very much driven by the synergies we have on the R&D side, by the development of targeted medicines. The real value is that we can leverage the different capabilities across the entire Roche Group," says Roche Diagnostics ’ CEO Severin Schwan. "You need tissue-based tests to achieve the necessary sensitivity and specificity to tailor therapy," Hunziker added.

With Ventana in the fold, Roche believes it would have a complete set of diagnostics technologies for the development of oncology drugs and companion diagnostics, including for therapy selection. After all, the smaller diagnostics company, an expert in both immunohistochemistry and in situ hybridization techniques, has among its products tests to gauge the potential response to EGFR inhibitors and to Novartis AG ’s imatinib (Gleevec). More importantly, unfettered access to Ventana’s technology would allow Roche to begin the companion diagnostic development process—for partners as well as for its own pharma division—early, even at the preclinical stage. "The earlier you start the exchange of ideas between pharma research and diagnostics, the better chance you have to come in parallel with the development of a companion diagnostic," Hunziker explained.

No doubt Hunziker was thinking of Plexxikon Inc. ’s PLX4032 cancer drug, which inhibits a mutation in the b-raf gene, V600E, which is present in roughly two-thirds of melanomas. Roche in-licensed Plexxikon’s compound in 2006 for $196 million. [See Deal] But even before Roche took rights to it last fall, the two companies had begun a diagnostics collaboration around a molecular test for the mutation. Now, Roche intends to seek approval for the drug with a companion diagnostic, which it will market in tandem. "That was the best of both worlds because we got to align the diagnostic and pharmaceutical development processes," notes Walter Koch, PhD, VP and head of research for Roche Molecular Systems Inc.

Roche is committed to this co-development strategy, and Koch acknowledges that such early development of a diagnostic has risks. "We’re subject to the attrition rates of pharmaceuticals, but there are ways to mitigate those risks and their financial consequences." Even when the goal is to have a companion diagnostic ready for launch at the same time as the drug, there’s no need to invest in its full-blown development prior to knowing some of the results of a pivotal trial, for example. A kit designed to work on the instrumentation platform, with final chemistry, "is more than adequate," says Koch. "There’s ample time between interim analysis and filing to do what needs to be done," including making three production lots, testing, and generating requisite documentation for regulators. And although it’s early days in terms of actually seeing tandem drug-diagnostic approvals, Koch also praises the Food and Drug Administration for creating an environment "within which this area of personalized medicine can flourish, if it makes sense, without unduly burdening the diagnostic or the therapeutic."

Emphasis on the Platform

Of course, the diagnostic platform used is an integral component of any molecular test, and one of the most complex aspects of the approval process for drug-diagnostic tandems. Roche’s molecular diagnostics unit has developed know-how around adapting microarray technology to clinical diagnostics, via a series of collaborations with Affymetrix Inc. [See Deal] [See Deal] [See Deal] [See Deal] It’s already used Affy’s GeneChip technology to develop clinical diagnostic tests for mutations in the p450 and cystic fibrosis genes—Walter Koch joined Roche initially to head up that effort. Now Roche is applying the same tools to the development of diagnostics in tandem with its own drugs, including a p53 diagnostic for a cancer drug that inhibits MDM2, which binds to wild type p53.

But while its recent deals for life-science tools may also be aimed at diagnostics and personalized medicine, that’s very far down the road.

In June, Roche paid $272.5 million for DNA microarray firm NimbleGen Systems Inc. [See Deal], three months after buying the next-generation sequencing firm 454 Life Sciences from CuraGen Corp. for $155 million. [See Deal] Roche also added an immunoassay technology platform by buying BioVeris Corp. in April 2007 for $600 million. [See Deal] (Roche had spun off BioVeris in 2004: its electrochemiluminescence technology was part of Igen, which Roche had acquired a year earlier. [See Deal])

As research tools, the microarray and next-generation sequencing platforms complement Roche’s development of diagnostics. There’s a continuity between high-throughout sequencing, genotyping, and eventually the creation of molecular diagnostic test content. But as businesses, at least at the moment, "they are in different places," Koch explains.

"Everyone’s talking about the $1,000 genome," he acknowledges, but as developers of clinical diagnostics, "frankly we wouldn’t know what to do with that information even if we could get it, because we don’t know enough of the biology yet." The instruments are designed to yield huge amounts of sequence information from a single sample, but the challenge in diagnostics, he points out, is to evaluate analytes in many individuals. "To harness 25 million potential sequence reactions for that purpose is a different play than if you’re trying to discover new mutations in genes."

Diagnostic sequencing will, however, increasingly become a part of the molecular diagnostics business at some point. "One might well want to sequence HLA," Koch says, rather than genotype it, because of the complexity of the loci being measured. "454 could offer distinct advantages there because it actually establishes ‘phase,’ which tells you what mutations are on the same chromosome, rather than your having to deduce a set of possibilities that you get when you sequence with traditional methods."

A Hint of Convergence?

Roche expects NimbleGen and 454 to stand on their own as growth drivers in the applied science segment. It has kept their management teams intact, and says it wants to do the same for Ventana. But unlike the tools companies, which it slotted into the applied science area of Roche Diagnostics, it does not intend to move Ventana into an existing area. Rather, it would maintain Ventana as a dedicated business unit.

Ventana could logically fit within the Roche Professional Diagnostics group, but Roche clearly sees it contributing significantly to drug development as well. Indeed, Ventana has a small drug-discovery services business. Leerink Swann’s Bruce Cranna notes that there were no questions about that business in the Roche call discussing Ventana, suggesting that it’s unimportant to the analyst community. Analysts are interested in the short term. Roche, however, appears to be starting to put together a long-term plan that assumes a greater interplay between diagnostics and drugs, and even a structure that assumes that personalized medicine will gain the traction that’s been long predicted for it.