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It Had to be You: Why Roche Was the Lone Suitor for Foundation Medicine

By Steve Dickman, CEO, CBT Advisors

January 16, 2015

Originally published on Xconomy

The buzz from day one of the JP Morgan conference in San Francisco earlier this week was the announcement on Sunday night by Roche that it was acquiring a majority interest in Foundation Medicine (NASDAQ: FMI) for a bit more than $1 billion in cash for a little more than half the company, which translates into $50 a share. Those were just the latest eye-popping numbers from Foundation, which went public in September, 2013, amid warnings of a biotech bubble. From its initial offering price of $18, Foundation proceeded to enjoy a first-day jump all the way up to $35 a share, straining credulity for those investors focused on the fact that the company had not received meaningful reimbursement for its flagship cancer diagnostic product FoundationOne.

It’s sixteen months later and Foundation still has not received the positive coverage decisions from Medicare or major private insurers that it would need in order to even dream of making money on its sequence-based diagnostic test. The stock had ridden down to $23 a share before the acquisition and there was plenty of short interest even at that level (pity those investors who did not cover those shorts on Friday!).

Roche was the only pharmaceutical company in the world that had a rationale for acquiring control of Foundation. It is best positioned to make the acquisition a success.

But Roche still went ahead and bought an unprofitable company for $1 billion in a transaction reminiscent of its purchase of a controlling stake in Genentech in 1990. Aside from the deal structures, which in both cases leave the US management team intact if now reporting to Roche HQ in Basel, there would seem to be virtually no similarity. Roche has moved far beyond its early-1990s status as a small-molecule-heavy European pharma eager to transition into biologics. At the time of the initial Roche transaction Genentech was already a powerful product engine, having developed early protein replacement therapeutics human insulin and human growth hormone with lots more in the pipeline and vibrant science to match. By contrast, Foundation has done little more than make losses on its diagnostics business.

But there is one big parallel between that deal and this one: In both cases, Roche believes that it has seen the future of the pharmaceutical industry. And it can only grasp that future by placing a large and risky bet on a US innovator company. Roche’s thorough transformation into a company invested in targeted therapies driven by disease biology supports my thesis that it was the only pharmaceutical company in the world that had a rationale for acquiring control of Foundation and that it is the one best positioned to make the acquisition a success.

In my view, the key reasons boil down to these:

  • Roche was early and fervent in its embrace of diagnostics as drivers of drug development and sales. I know only one top executive in the pharmaceutical industry who cut his teeth in molecular diagnostics and he did so at Roche– Dan O’Day, who was CEO of Roche Molecular Diagnostics from 2006 to 2010 and is currently COO of Roche Pharma. Once the Foundation transaction is completed, O’Day and two others chosen by Roche will join Foundation’s board of directors. Aside from the personal, Foundation also fell on fertile ground at Roche on the institutional level. Roche had already changed its drug-discovery focus to be more diagnostics-driven than most other pharmaceutical companies on virtually every level. As Roche CEO Severin Schwan declared in 2012: “More than 60% of our pharmaceutical pipeline projects are coupled with the development of companion diagnostics in order to make treatments more effective.” That number has almost certainly gone up.
  • Roche was the pharma that had most thoroughly integrated clinical genome sequencing into its trial protocols, long before it had figured out how best to use the data. In my work with biotech companies, I had been hearing for years how Roche had embraced sequence data as a key success factor for the pharma industry of the future. As soon as the cost of sequencing became halfway affordable (maybe $5,000 to $10,000 per full sequence), Roche began to require genome sequence data as a key data point from every patient in every clinical trial. If there was any doubt about how highly Roche regarded sequencing, its $51-a-share Illumina bid in 2012 dispelled it. (Illumina, whose CEO Jay Flatley said at the time that the bid seriously undervalued his company, now trades at $181). An executive speaking under condition of anonymity who knows Roche Ventures well confirmed that Roche places high importance on sequence data, both data which it has itself collected as well as data being collected by Foundation. As an aside, Roche Ventures had invested in Foundation two rounds before the IPO in 2012 and had no strings attached in the form of a promised acquisition or partnering deal. That investment is another indicator of the value Roche management placed on keeping up with the world of clinical sequencing. That executive told me on Monday that Roche was counting on Foundation’s data scientists to be able to make the most effective use of their own data banks of both sequence data and outcomes data and that the prospect of joining forces was irresistible.
  • Roche realized that it would face competition if another pharma company scooped up Foundation. Roche believes that in genomic profiling, it has identified a common theme for creating value in oncology therapeutics of whatever stripe – targeted therapies like kinase inhibitors; biologics like monoclonal antibodies; and even immuno-oncology approaches like checkpoint inhibitors. Having made this observation, it did not want anyone else to catch up. Combining Roche’s clinical sequence data and its drug pipeline with Foundation’s gene-level and patient-level insights clearly would realize the most powerful synergy. But in the hands of another pharma, the Foundation team and data sets could have posed competition. Ergo, Roche decided to buy it now.
  • Roche is counting on a shift from biochemical targets to genomic profile targets, especially in drugs for solid tumors. Foundation’s “poster child” cancer cases are those in which genetic profiling suggested – against all experience of oncologists and with no evidence from n-of-1,000 clinical trials – that cancer drug X, developed for, say, ovarian cancer, would work best in cancer indication Y (e.g. prostate cancer). Because the patient is desperate, the physician prescribes the drug and voila – there is a response or even a remission. This pattern echoes what has happened in blood cancers such as chronic lymphocytic leukemia (CLL), in which old-fashioned chemotherapeutic agents have been replaced by biologics like rituximab (Rituxan) and are being augmented or, eventually, replaced again by kinase inhibitors like ibrutinib (Imbruvica). This will likely happen in solid tumors as well: chemo as we know it will be scaled back (though, like that other blunt instrument, surgery, it will likely never completely disappear) and physicians will chase cancer cells through various waves of genetic mutations, each of which demands a different targeted therapeutic or biologic to hold it at bay. In that world, the company that is most on top of the mutation patterns and treatment patterns and can incorporate those into both its drug development efforts and its sales pitch, wins, or at least has an edge. Diagnostics will likely be an important part of immunotherapy as well, an area where Roche is currently weak. Right now companies like Juno (NASDAQ: JUNO), Kite (NASDAQ: KITE), Bellicum (NASDAQ: BLCM) and Novartis are taking baby steps with CAR-T. Most companies are focusing on surface antigens like CD19 that are widely expressed and therefore do not require molecular diagnostics.  To realize the full potential of these therapies, companies will need to match patient-specific tumor profiles with panels of off-the-shelf biologic reagents and cell engineering products. That’s where Foundation’s tests might come in.
  • Foundation is setting new standards in cancer genome analysis. Foundation has raised the bar in the accuracy of genome-based tumor profiling (sensitivity, specificity) by something like a factor of three, and built robust and scalable informatics and analytics. Roche was already using the Foundation platform on a limited basis and realized that it was simpler to expand that use rather than to try to copy it.

Since the last few pharma mega-mergers, the industry’s biggest players have gone in wildly different directions. Novartis embraced gene therapy and gene editing. AstraZeneca doubled down on the biologics franchise it obtained with the acquisition of MedImmune. Bristol Myers and Merck have raced ahead in checkpoint inhibitors. Merck, Sanofi and to some extent Pfizer have rapidly expanded investment in “beyond the pill” and “digital interventions” (apps as drugs). And Roche took up diagnostics and genetics. For Roche, drug development, especially in oncology, is all about “genetics-driven medicine,” which in their view requires “genetics-driven drug development” and “genetics-driven marketing.” No one else has placed such a big bet on genetics though all pharma companies are certainly exploring it. For example, AstraZeneca, Johnson & Johnson and Sanofi recently announced a collaboration with Illumina (NASDAQ:ILMN) to develop a “next-generation-sequencing based test system for oncology.” In some sense, if Roche wins this one, others – e.g. those betting on checkpoint inhibitors and CAR-T cells – might lose out.

In CBT Advisors’ world of venture-backed biotech companies, this landscape poses significant challenges. Gone are the days when a biotech’s innovation would be appreciated by as many as five or ten pharma companies at the same time (there are barely fifteen left that regularly carry out M&A) and there could be a big bidding war. The biotechs’ leverage is not what it used to be. Counterbalancing that is the obvious productivity flop in pharma R&D. Biotech is the only place pharma can turn for real innovation. And turn they do, early and often.

This creates a bonanza for firms like mine that assist early, science-driven companies in managing their public positioning and their BD pitch from day one to create the largest possible exits. Now more than ever, the right story sells, just maybe to only one or two bidders. In Foundation’s case, the billion-dollar number was probably what it took to get the company’s pre-IPO investors (who included Google Ventures and Bill Gates not to mention smart funds like Casdin Capital) to give up on at least some of their dreams of long-term returns in exchange for a sweet 10-12x (I’m guessing) on their last pre-IPO investment from early 2013.

From Foundation’s point of view, the deal does three things, all of them good:

  • Cashes out the early investors at a price they can accept.
  • Delays, perhaps indefinitely, the need to break even on selling tests and shifts the focus to drug development and companion diagnostics
  • Relieves the constant pressure to market the company’s analytic services to multiple pharma companies in deals that have been the main source of revenue for Foundation to this point. That pressure was undoubtedly going to become heavier as Foundation’s pharma partners realized that, quarter after quarter, there was no reimbursement coming from Medicare and little from other payers, leaving pharma to provide the vast majority of the company’s source of revenue. (A first small insurer in Grand Rapids, MI, announced coverage of FoundationOne and another Foundation test in October, 2014.)

Back to why the acquirer had to be Roche: remember that over the last 25 years, Roche has had the undoubtedly humbling but ultimately very profitable experience of owning Genentech. Revenues and product pipeline from that acquisition long ago overtook those products from Roche’s own drug development in volume and importance. In some sense, Genentech has come to own Roche. Since Roche is nowhere near as advanced in gene therapy as Novartis nor as advanced in checkpoint inhibitors as Merck and Bristol-Myers, the move to own Foundation is an attempt to be the best it can be as a genetics-driven drug developer and marketer. No other pharma would have seen this deal that way. When and if Foundation’s investment bank called around looking for better offers, I bet no one called them back.

For Roche, the deal will either turn out to be a leap frog or, maybe, a dead end. But if cancer therapies, especially for solid tumors, really do wind up getting developed and marketed in a genome-driven way – and many trends point in that direction – then this move will have turned out to be prescient indeed.

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Foundation’s IPO Isn’t Bubbly, It’s a Jolt for Genomic Diagnostics

By Steve Dickman, CEO, CBT Advisors

September 25, 2013

(Originally published on Xconomy)

Foundation Medicine, the Cambridge, MA-based cancer diagnostic company, reminded me of the 2000 genomics bubble when it went public this week. The company sold its IPO shares at $18, and the stock almost doubled in its first day of trading, closing at $35.35, a 96% increase in stock price off an already bumped-up IPO price. That gives the company a market value of almost $1 billion.

Frothy, yes, but not quite bubbly

First day froth? Or sustainable value creation?

This impressive rise represents one of two potential outcomes. It could be that either genomics is here to stay as a diagnostic tool and Foundation is a harbinger of this change. Or, this could be the peak of another bubble featuring a money-losing company hyped by scientific leaders but still unproven in the marketplace. In that view, Foundation’s IPO is not just hazardous to the company’s most recent investors. It may be damaging to the whole field of genomics-based healthcare and to biotech stocks in general.

Foundation faces a long road but I am inclined to take the optimistic view. Genome sequencing is a powerful technology that has declined so much in price, so fast, that it has outpaced Moore’s law. The real value in sequencing is not the raw data, which are becoming a commodity, but rather the interpretation of that data for specific patients. In ways I will explain below, Foundation sits just at the nexus of that new data and its own increasingly powerful interpretation engine.

My first take-home from FMI’s monster IPO is, don’t worry so much about the company’s past losses ($22.4 million as of 2012, according to the IPO prospectus). Look instead at the amount of money raised ($106 million on top of $99 million raised since the company was founded in 2009) and consider its practical value: research funding.

When the 2000 genomics “bubble” was inflated, companies such as Incyte, Human Genome Sciences, Celera and Sequenom raised eye-popping amounts of cash at even more eye-popping valuations (one day in February, 2000, Sequenom hit a $4 billion market cap on nearly nonexistent revenue), there was no way for that money to create value in a reasonable time frame. What followed was a decade of retrenchment as one company after another started the arduous process of home-growing its own drugs (Incyte has notably succeeded at this) or shifting to a more sustainable business (such as Sequenom’s prenatal  test for Down syndrome and other chromosomal abnormalities).

The fresh money for Foundation Medicine, plus the inevitable follow-on offerings, will fuel a powerful research platform that is in a position to discover and then apply a number of new insights into how genetics influence patients’ response to cancer therapies. That, in turn, has the chance to improve the success rate for physicians in treating cancer using both marketed and experimental drugs.

My second take-home is that the large fundraising gives the company a greater survivability in the absence (until now) of reimbursement. You don’t have to read the prospectus to know that one of the key risk factors for FMI is the lack of buy-in from payers. As Ben Fidler of Xconomy wrote, “Foundation began selling its diagnostic, known as FoundationOne, at the American Society of Clinical Oncologists in June, 2012. And while demand has been rampant—-some 1,500 physicians in about 25 countries have ordered the test since—FoundationOne isn’t covered by any plan. Rather, coverage is determined on a case-by-case basis, meaning the company is likely going to have to gather meaningful evidence from clinical trials to prove to payers that its test is making a big difference for patients.” Reimbursement is still a hurdle, probably the biggest. Hold a big IPO and voila – funding is there for these trials.

Personally, I am thrilled that Foundation’s approach reflects a strong shift toward using personal genetic tests (in this case whole genome sequencing) to drive medical care. The term “personalized medicine” has been overused for so long as to become a sad cliché. But changing a patient’s treatment based on a genetic test and especially initiating a treatment that would otherwise not have even been considered – that is a watershed. An idea like Foundation’s, in which you scan the genome of an individual patient for variations in more than 200 genes, is a medical reality today that was barely even conceivable five years ago.

Furthermore, Foundation is barely dependent on its test revenues at the moment. The bulk of its revenues (something like 85%, I’ve heard) still come from partnerships with pharmaceutical companies. Its investors, both private and public, may well grant Foundation the time it will need to achieve reimbursement and make a compelling case to enough physicians to drive test adoption and growth.

Critics have correctly observed that there is little evidence for the utility of most of the genes on Foundation’s first panel, FoundationOne. Something like two hundred genes are assayed when barely twenty are known to be drivers of cancer. As I understand it, this is where Foundation’s entrepreneurial strategy comes into play. By aggregating data on the next 180 genes rather than focusing just on the 20 genes of known relevance to cancer patients, Foundation hopes to bring a much greater degree of clarity and utility to cancer therapy, which has traditionally been based on a brutal process of trial-and-error. Many patients (and their physicians) don’t have enough time or scientific insight to go through a series of single-gene diagnostic tests to find out which drug might be best for them. Even if patients demanded this one-at-a-time approach, it is not at all part of current medical practice. For the sake of cancer patients, I hope Foundation Medicine succeeds with its broader approach.

Critics have also observed that Foundation’s business model is predicated on the company being paid $5,000 or more for a test (according to Xconomy, recently out-of-pocket payment by patients or one-off payments from insurers have been running more at the $3,800 level). But the cost of sequencing is very low! Can’t the test be less expensive? Where does all that money go? The answer, to me, is clear: the money goes to research. The model reminds me of crowdsourcing, a funding mechanism that has just become a viable mechanism for funding biotech companies. In Foundation’s case, it is a way to raise money from people who have a real need (cancer patients), provide them with sufficient value (sequences of genes with known implications for cancer therapy) and then increase the incremental value of the test for the next round of patients.

To succeed, this approach has to scale. That is, insights obtained from the first 3,000 patients have to become more valuable for the next 30,000 and so on. There have to be increasing returns or else there will be a backlash at the level of pricing and adoption. In the absence of reimbursement, the only way to make this work is to raise a lot of money (through IPOs, secondary share offerings, pharmaceutical industry partnerships, self-pay from patients, international adoption or whatever) and pour it back into the company. The field of genomics spent several years wandering in the wilderness of “genome-wide association studies” (GWAS) which were supposed to identify canonical mutations that affected large numbers of individuals. That barely turned out to be the case. Now mutation hunters have come to the opposite conclusion: it is individual mutations, perhaps even those with an “n” of just one person, that will matter the most in improving cancer therapy. The company or entity that builds the largest database of these mutations – and applies them in cases where there is an “n” of two or 20 – will become a go-to source for insight into specific patients’ cancers.

There are three dangers here: first, that scaling cannot be achieved quickly enough to justify reimbursement. The tests Foundation is doing are by their very nature outside of the parameters such as sensitivity and specificity that are traditional metrics for payers. So their results have to be so overwhelmingly good that payers change the rules in order to reimburse for the tests. That is likely to happen slowly if it happens at all.

Second, unless great insights arise from the additional genes, Foundation – with no real intellectual property on the content of its assay – will fall prey to commodity entrants offering tests at much lower price points. That is reminiscent of the dynamic I see playing out in non-invasive prenatal testing (NIPT).

Third, what if Foundation succeeds and gains insights from its database (paid for by patients) that lead to a true competitive advantage? Won’t there be a clamor for public release of Foundation’s data, similar to what happened when Myriad Genetics lost its Supreme Court case and no longer had patent coverage over its BRCA1/2 test? It will be interesting to see this play out.

In my view, Foundation’s IPO is a turning point that will only boost the many efforts to make the genome a powerful ally in the fight against cancer. Given the massive drop in sequencing costs and today’s vote of confidence, it will not take too long for similar insights into other diseases to follow.

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