Published on Sep 24, 2019
As the FTC’s review of Illumina’s (ILMN) proposed $1.2 billion Pacific Biosciences (PACB) acquisition enters its late stages, agency staff has deposed third parties and lined up potential witnesses for trial, indicating the gene-sequencing firms haven’t convinced staff that their merger wouldn’t harm competition, sources familiar with the matter said.
FTC staff has expressed particular concerns that the deal would lessen competition in the sale of instruments that sequence human genomes, one of the sources said.
The deal has attracted some opposition from customers that use the companies’ gene sequencing instruments, another of the sources said.
The large FTC staff contingent assigned to the case is also troubled by the companies’ internal documents indicating that they consider each other to be close competitors, the sources said.
If staff recommends a lawsuit to block the deal, it’s considering doing so under Section 2 of the Sherman Act, rather than solely under Section 7 of the Clayton Act, the statute on which enforcers usually base their merger suits, one of the sources said.
Senior FTC officials and antitrust lawyers have said that Section 2, the federal statute that proscribes monopolization, might be effective in blocking acquisitions by dominant firms that threaten nascent competition.
Industry sources described Illumina as a dominant firm that takes about 80 percent of the gene sequencing market’s global revenue. PacBio, a relatively small player in the sequencing market, has articulated plans to aggressively grow its market share, and in April introduced its Sequel II system, which industry sources said could increase the firm’s competitiveness with Illumina.
Nonethless, Section 2 is a relatively blank slate in the merger context, and an FTC decision to pursue an action against the unconsummated deal under the statute would represent a broadly unprecedented approach to merger enforcement.
An FTC spokesperson declined to comment. Spokespeople for Illumina and PacBio didn’t respond to requests for comment.
Timing, CMA questions. The FTC’s review has slowed recently, as the UK’s Competition and Markets Authority’s (CMA) ongoing phase 2 review of the deal prevents Illumina and PacBio from
closing their merger, and the FTC doesn’t need to pursue a federal district court order preventing the deal’s completion, two sources said. The CMA phase 2 review’s statutory deadline is December 11.
The FTC might wait until December before acting, the two sources said: That’s when CMA is scheduled to publish a final report on the deal.
This timing could prove inconvenient for Illumina and PacBio, whose merger agreement includes a November 1 end date. If the companies haven’t achieved required antitrust clearances by then, either firm can abandon the transaction, and Illumina would be liable for a $98 million reverse breakup fee.
The parties should know by mid-October the deal’s likely fate in the UK, when CMA discloses its provisional findings and considers possible remedies. The authority’s final decision usually tracks closely to the provisional findings.
While both companies’ machines have become increasingly vital tools in the development of drugs, medical diagnoses and agriculture, Illumina and PacBio have argued their instruments are complementary because they have different prices and capabilities.
In filings to the CMA, the companies have argued that PacBio’s native long read and Illumina’s short read technologies don’t compete, and fall into distinct relevant product markets.
Short-read technology sequences DNA into small fragments, typically 150 base pairs on Illumina machines; PacBio’s long-read machines, in contrast, can sequence greater than 20,000 base pairs.
Short-read and long-read technologies are optimal for different tasks, Illumina said in response to CMA’s phase 1 decision. Long-read machines, for instance, are best for the initial “de novo” generation of complex genetic sequences, such as a plant’s genome, whereas short-read technology works better for small, simple genomes, Illumina said.
The companies have also emphasized cost differences, and submitted an analysis during the CMA’s phase 1 investigation arguing that because short read offered “materially lower” operating costs than long read, customers would always choose short-read sequencing unless only long read was capable of meeting their needs.
The CMA’s phase 1 decision to refer, however, broadly rejected these arguments, finding that short-read and long-read sequencing are “technically interchangeable” for most applications.
Short on cash. The companies have stressed to FTC staff the precarious financial situation of PacBio, which they said would likely go out of business if the Illumina purchase falls through, sources said.
PacBio had about $67 million of cash, its equivalents and investments on June 30, according to an August 6 PacBio filing with the Securities and Exchange Commission reporting Q2 results.
At the company’s current spending rate, that’s enough cash for another 12 months of operations, the filing said. Without additional cash infusions, the company may have “to reduce sales, marketing, engineering, customer support or other resources devoted to our existing or new products, or we may have to cease operations,” according to the filing.
Still, PacBio would receive a $98 million reverse breakup fee from Illumina if the parties abandon the merger due to antitrust opposition. But so tight are PacBio’s finances that it would need “timely receipt” of the fee to repay $16 million of its notes, according to the filing.
Despite these warnings, PacBio did beat Wall Street’s expectations in the second quarter, and reported a 14 percent year-over-year increase in revenue, in part due to the success of its new Sequel II machine.
Nonetheless, the company reported a $24.6 million net loss in the quarter, and revenue from consumables fell from a year earlier in a sign that customers were using PacBio machines less frequently.
Conflicting customer views. Customers offered conflicting views to The Capitol Forum on the deal’s potential impact. Some agreed with the companies that Illumina’s short-read machines—which dominate the gene sequencing market—and PacBio’s long-read products are used for different purposes and aren’t close competitors.
Other customers, however, said that the technologies do compete. The range of answers is similar to what customers told CMA, according to a summary of calls with UK gene sequencing customers the agency published on September 19.
Several customers told The Capitol Forum the technologies didn’t overlap.
“I would not say that Illumina short read technology competed with [PacBio] technology really because they are used to solve different scientific problems,” said the director of a research institute who wished to remain anonymous.
Another difference is price: PacBio products cost three to 10 times more than Illumina’s for similar applications. The high cost turned off some researchers who otherwise liked the PacBio machines’ capabilities.
“Price is the biggest downside to PacBio sequencing,” said a second customer who wished to remain anonymous.
PacBio’s technology would thrive under Illumina’s stewardship, benefiting researchers, the customer said.
“Illumina is very interested in developing the PB tech and will not bury it,” the customer said, adding that without the deal, “PacBio will go out of business.”
Competition between long read and short read technologies. Some customers said it would be better if the companies don’t merge because they do compete on certain applications, giving researchers buying options. For instance, both companies’ machines could be used for RNA sequencing, which can assess changes in a cell that might indicate a disease, the customers said.
PacBio also has been lowering prices to better compete with Illumina, sources said.
PacBio introduced its Sequel II system on April 24 in a new product launch the CMA phase 1 group said would have the effect of “increasing output and reducing cost of sequencing considerably.”
The phase 1 decision also cited statements from some third parties who considered PacBio “capable of becoming the strongest competitive constraint on Illumina as a result of the release of its Sequel II system.”
In its September 19 summary of customer calls, the UK agency reported that “all customers the CMA has spoken to who have had access to Sequel II have said its performance has met or exceeded their expectations.”
Some third parties told the CMA that long-read technology could replace short-read machines in the next five to 10 years. While Illumina has disputed this scenario, the CMA said the company’s internal documents indicated that long read technology presented “substantial risks” to its commanding position in the industry.
Although expressing skepticism that long-read machines would push their short-read counterparts totally out of the marketplace, the research institute director told The Capitol Forum, “Long read may dominate if it can [get] sufficiently high throughput and [is] inexpensive.”
The companies have argued to antitrust enforcers that long-read technology will never reach the throughput and price points of short-read machines, one source said.