What Roche’s Acquisition of Foundation Medicine Means for Investors

Only months after a standstill agreement between the two companies expired, biopharma giant Roche Holdings (NASDAQOTH: RHHBY) has agreed to acquire Foundation Medicine (NASDAQ: FMI) lock, stock, and barrel. Roche had already owned more than half of Foundation Medicine, so the decision to buy the company outright shows it’s more confident in the future of personalized cancer treatment than ever before. Is this deal a needle-mover?

In this clip from Industry Focus: Healthcare, host Kristine Harjes and Motley Fool contributor Todd Campbell discuss how this tie-up impacts investors.

A full transcript follows the video.

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This video was recorded on June 20, 2018.

Kristine Harjes: First up, Todd’s going to take a victory lap for pitching Foundation Medicine, ticker FMI, as his top healthcare stock to buy last October. The stock is up 229% since then, a high-water mark it hit after the announcement on Tuesday of this week that Roche is buying the company — or, rather, the part of the company that it doesn’t already own. Todd, congratulations on a stellar pick! I hope you had put your money where your mouth was.

Todd Campbell: I did, Kristine! I did! So, of course I’m smiling. But for every victory, there’s always going to be one that isn’t a victory, right? You have to be humble when it comes to this kind of stuff.

But, big news for investors and owners of this company, and potentially for people who are making bets in personalized medicine. I think that anybody who wants to learn more about Foundation Medicine and what it may mean to Roche over time could, obviously, go back to our show from last fall. Kristine, when was that?

Harjes: It aired on October 18th, if anyone wants to check it out. It was during our Pitch Week, where we had all of the fool.com writers in Fool HQ — which is rare, it only happens once a year — and we asked a bunch of them to pitch a stock from the sectors that they cover. Todd pitched Foundation.

Campbell: Right. If you want to go back and listen to that show, obviously, Foundation, there’s no real reason to own it, and I’ll tell you why in a second, from here. But there may be a reason to consider what the impact could be for Roche. So, it might be worth going back and just taking a listen, given the fact that it will become a part of Roche once this deal closes. That’s expected to happen later this year.

The nuts and the bolts, Kristine, investors are getting $137 per share. That’s going to be paid out in cash, not stock. That’s a 29% premium to what it was trading at late last week, and a 68% premium to the 90-day volume-weighted average, so it’s a pretty healthy premium. It values the amount of the company that Roche didn’t own at about $2.4 billion. If you include what Roche owned, then that would value the company at $5.3 billion. Maybe what’s really interesting there for investors just thinking about this space more broadly is, that represents a fairly massive price to sales ratio for this company. They’re obviously estimating that this is going to become a much bigger market over time.

Harjes: Right. Roche has not been shy previously about paying up to have a stake in this company. They previously had a majority stake, acquired back in January of 2015 at $50 a share, which was, at the time, even twice the price that the stock was trading at on the market. Now, they’re taking up the rest of the stake in the company for, as you mentioned, $137, which is another pretty sizable premium to where the market had previously valued this company. So, Roche is very interested.

This makes a lot of sense. What Foundation Medicine does really builds on Roche’s prior efforts in personalized medicine. Foundation Medicine’s goal is to make comprehensive genomic profiling, or CGP, the standard of care in cancer. They want to be able to look at solid tumors and actually figure out what the genetic profile that tumor is, and see whether or not there’s a more targeted therapy that might be beneficial for that patient.

Campbell: Right. It’s basically taking your information, your genetic code, taking that information and then matching you up with the most appropriate therapy. That may be a therapy that’s already won approval, that may be a new therapy that’s making its way through clinic. What it does is, it simplifies the whole process, both for the patient and for the physician or the oncologist who’s coming up with the treatment plan.

What’s really interesting about this, and probably why Roche acted now, is that that deal where they took the over 50% stake in it previously, they had a standstill agreement. That standstill agreement expired earlier this year. That freed them to go out and make a bid to gather up the whole company.

This all happens at the same time that’s Foundation Medicine just won approval for a pretty comprehensive screening test, its latest product, which is the FoundationOne CDx. They’ve just achieved winning a reimbursement from Medicare for the use of this screening tool in people with advanced cancer. Advanced cancer, they estimate there are about a million people out there who could be tested for this using this screening system. To put that in perspective, only about 150,00 patients are currently being tested, so there’s a pretty large market opportunity here, especially when you consider that over time, regardless of if it’s advanced cancer or early stage cancer, this kind of screening could become standard.

Harjes: Yeah, absolutely. In the past, drug makers have had to come up with a separate diagnostic tool to be used with the personalized medicines that they’re developing. The cool thing about FoundationOne is that it has this vocabulary that you can add to over time. The drug makers can team up directly with Foundation Medicine to use this already-approved tool in their FDA applications for their personalized therapies. Even the Medicare reimbursement itself, the way that that’s structured with the national coverage determination, or the NCD, is such that it can readily expand as more tumor types that need this companion diagnostic tool come into play, so you can add and expand the use case for FoundationOne.

For now, what this means for the company is that Foundation Medicine will operate under Roche as a separate and autonomous unit, which is reminiscent of Roche’s strategy with a bunch of different acquisitions. The biggest one that people will recognize is that of Genentech, which was an enormous acquisition. It was a $47 billion purchase, and it was left largely alone. Actually, the Genentech acquisition followed a similar structure, as well, where Roche had a 56% stake in Genentech before it bought the entire thing. They did a similar acquisition with a company called Flatiron, where they had a small stake and then came back to acquire all of it. This is very typical of Roche. I do trust them to integrate the company appropriately.

I think it’s a very exciting development for the field of personalized medicine. If a giant company like Roche is so clearly willing to invest in personalized treatments, that really points toward this being the future of cancer care.

Kristine Harjes has no position in any of the stocks mentioned. Todd Campbell owns shares of Foundation Medicine. His clients may have positions in the companies mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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