September 10, 2003 - 11:33am EST by
2003 2004
Price: 59.70 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 1,420 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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A rare special situations opportunity has arisen in the shares of IGEN due to a complex acquisition involving a spin-off and multiple confusing transactions. Another factor clouding IGEN is that there are two independent analysts that follow it, Sturza Medical Research and Belmont Capital, and no Wall Street analysts. And only one analyst has written research on IGEN. No one is really following IGEN.

These cloudy circumstances are allowing investors to buy shares in the “Newco” spin-off at very low valuation. With further research and greater exposure, investors will realize that the new “Babygen” could be worth many times what it is selling for pre-spin-off.

Roche Litigation eventually leads to Acquisition

Roche and IGEN have been in bitter litigation for over 5 years. The litigation was confusing and convoluted but it works in investors favor, as the picture is clouded. The acquisition and spin-off are the end result of all of this litigation. This is why IGEN represents such an opportunity now. The following is a summary of the litigation history from the Deal.com.

Roche acquired a license to the technology in 1998, when it bought Boehringer Mannheim GmbH, which had entered into a license agreement with Igen in 1992. Before the merger, Boehr-inger invested more than $350 million in the Igen project and brought two products to market in 1996 and 1997. The product line continued to develop under Roche, which by 2001 was the world's second leading producer of diagnostic kits. The Roche line that contained the technology, the Elecsys series of diagnostic instruments and assays, had fiscal 2002 revenues of $404 million.

In 1997, Igen sued Boehringer in U.S. District Court in Maryland, claiming that the defendant had underpaid royalties and failed to use its best efforts in developing products based on the Igen technology. With its purchase of Boehringer, Roche inherited the suit.
The case was central to the outcome of Igen's suit against Roche in Maryland. After a 10-week trial, the jury in the Maryland litigation awarded Igen $400 million in punitive damages based on Igen's theory that Roche's decision to settle the Serono litigation amounted to unfair competition. The jury also awarded Igen an additional $105 million in other damages.

The U.S. Court of Appeals for the Fourth Circuit upheld Igen's right to end the license July 9 in an opinion written by C. Arlen Beam, a senior circuit judge on the 8th Circuit, and joined by judges William Traxler Jr., and Dennis Shedd. But the higher court nixed the punitive damages award. The appeals court also set aside $82 million of the damages the jury awarded for Roche's alleged breach of good faith and fair dealing.

The stock market recognized that Igen's court win was Pyrrhic; Igen's shares fell to $29.60 from $33 the day after the ruling came out. In addition to losing $482 million in damages, Igen's license to Roche accounted for about half of the $56 million in Igen's fiscal 2002 sales. Igen withdrew its license after the ruling and filed patent infringement lawsuits against Roche in the U.S. and Germany to prevent sales of Roche products that use Igen technology. The ruling left Roche without a license critical to a market-leading product line and Igen with a revenue shortage. After a weeklong surge in its share price, Igen issued a statement July 22 saying that it was in talks with Roche Diagnostics about its possible acquisition. Two days later, the deal was announced.

Deal Terms

Roche is essentially buying IGEN for the non-exclusive rights to IGEN’s technology. Roche is buying IGEN for $47.25 a share in cash and simultaneously spinning off basically all of IGEN in the form of a new company. Once the acquisition is consummated, Roche will not have to pay IGEN any royalties and the new “BabyGen” can go out and license its technology and sell its own products.

Even better for investors, Roche is paying off all of IGEN’s debt and then giving BabyGen $118 million in net cash. So, the new IGEN will be debt free and have $4.37 a share in cash (27 million shares outstanding).

IGEN also receives rights to improvements in Roche’s Elecsys line and has the opportunity to pay royalties to license out Roche’s PCR license. PCR stands for (P)olymerase (C)hain (R)eaction, This technique amplifies small amounts of DNA & RNA so that these molecules can be measured. Drug discovery and testing may be shortened and become less hit-and-miss; genetic disorders can be tested for and of course DNA testing is talked and written about everywhere in the various media for forensic purposes.

What is the market valuing BabyGen at?

Outside of the cash per share of $47.25 Roche is paying and the additional $4.37 share in cash that the spin-off will have, investors in IGEN now, get the “BabyGen” spin-off for $8.38 a share or $225 million.

The Value of IGEN’s Technology

Usually it is very hard to determine what a technology’s value is, but in this case the acquisition by Roche and the success of their Elecsys product line provides dramatic evidence in support IGEN’s technology.

Considering that Roche is paying $1.2 billion for non-exclusive technology rights, $225 million seems tiny. Now, clearly a good portion of the amount Roche paid is past due royalties and a penalty for not paying the right royalty in the past.

The key question: What will competitors such as Abbott Labs, Johnson & Johnson or Beckman Coulter pay for a license?

A caveat is that Roche early on based their product line on ORIGEN and that they backed themselves into a corner. It is possible that IGEN’s technology is run of the mill and it only got lucky because Roche bet the farm on ORIGEN.

Roche is growing its Elecsys product line at 15% a year, in a super competitive industry that is growing at 6% a year. Roche’s current annual sales rate is $455 million, and they conservatively expect in five years that the sales will be $900 million. Considering a $500 million product sales growing at 15% in a competitive market, it is no wonder Roche paid $1.2 billion. The growth in Elecsys shows how compelling IGEN’s technology is and how readily accepted it is becoming.

The question becomes outside of Roche’s niche product line, what is the value of IGEN’s technology in every other field? There is one thing I’m sure about and that is the value is greater than $225 million. There is a deeper more thorough walkthrough of the valuation question later in the report.

What Exactly Is IGEN’s Technology?

IGEN’s technology is called ORIGEN, and is based on electrochemiluminescence (ECL) technology. Basically, ECL detects and measures biological substances by illuminating those substances. ECL technology and ORIGEN in particular offers speed, sensitivity and flexibility compared to existing technologies.

Here’s how ORIGEN works:

1) IGEN labels a targeted substance in a sample using a compound.
2) Then the newly labeled substance is bound to magnetized beads.
3) The beads are then separated from the rest of the sample with a magnet.
4) When they “stimulate” the substance and the label, they emit light at a certain wavelength.
5) The intensity depends on how much label is present, which in turn depends on how much substance there is.
6) The light can they be measured with a high degree of accuracy.

Here are the benefits of ORIGEN:

1) Testing is simple and can even be automated
2) Very flexible whether large or small molecules are used or DNA or RNA
3) Reduces cost per test by reducing the number of reagents needed and the steps required to prepare the sample.
4) Enables high throughput through reduced setup time
5) Allows detection at very low concentration
6) Precise
7) Allows longer shelf life of reagent

Applications of IGEN’s Technology?

There are three main markets that IGEN is focused on, BioDefense & Industrial, Life Science and Clinical Testing.

In the biodefense and industrial testing market, ORIGEN can be used in testing for viruses, toxins, bacterias, etc. For example, IGEN is working with the government for testing for anthrax. Their technology could be used as a front line defense in testing for bioterror attacks.

In industrial testing, food processors could use ORIGEN to test meat for E.Coli or other bacteria.

There are a number of applications in the Life Science market. ORIGEN can help validate targets through genomics, screen through combinatorial chemistry, and clinical trail testing of drug candidates.

The other major market is Clinical Testing. This is the market in which Roche has its Elecsys product. This market includes hospitals (physician offices, ERs), blood banks and reference labs.

The BioTerror/BioDefense Play

IGEN is working with a who’s who of governmental and biological institutions. Here is a list of current known activity:

1) Automated Biological Agent Testing System at the U.S. Army’s Edgewood Chemical & Biological Center, Aberdeen Proving Ground. IGEN in conjunction with Beckman Coulter to automate sample preparation and plate handling for ORIGEN’s immonassays.

2) R&D Agreement with the U.S. Army Medical Research Institute of Infectious Diseases for detection of biological toxins.

3) Developing a botulinum toxin test for the CDC (Center for Disease Control)

4) Contract with the DoD (Department of Defense) to develop assays for the detection of select agents in food

5) Integrating ORIGEN’s technology into Air Force biological testing program.

IGEN also plans to further develop ORIGEN-based products for the biodefense market, such as the M-SERIES M-1M analyzer. These plans include an instrument system that can be both miniaturized and "ruggedized" for use by soldiers in a variety of settings, "first responders" such as fire, police and ambulatory medical workers, hospitals, food processors, field inspectors from the Environmental Protection Agency (EPA), U.S. Department of Agriculture, and Food and Drug Administration (FDA), and border patrol inspectors. (From 10-k)

Clearly, IGEN has a multitude of opportunities to win contracts and the potential for product sales in the bioterror market. I would note that while there has been a lot of talk from the government about protecting against bioterror, there has been very little in the way of money has been spent. If the government starts spending serious money on biodefense or God forbid if there is ever a bioterror scare; IGEN could see large amounts of money thrown its way. A recent example would be Invision (NASDAQ: INVN), a manufacturer of bomb detectors, after 9/11. The stock went up 5 times.

Comparables and their Valuations

IGEN is a unique company and a unique situation. However, the following are a group of comparables. In point of care diagnostics, IGEN could be compared to BSTE, BLUD, AFFX, CTEC, ABAX, TPTH, CYTC. These companies trade for an average of 3.54 times 2004 sales and 19 times 2004 estimated EBITDA.

In Bioterror, AVAN, DOR are the comparables I could find. AVAN trades at 13 times sales and DOR has no sales, earnings or book value. These are pure hype/air type of stocks. Both stocks are up more than 100% this year.

History of special situation spin-offs Similar to IGEN

Gen-Probe (NASDAQ: GPRO) was spun off from a Japanese parent in September of last year at around $14. It now trades near $63 a share and sells for over 7 times sales. It was spun-out with zero hype and no analysts covering the story. Now there are eight analysts. IGEN is in a similar field and while not being spun off from a Japanese parent, IGEN for the past five years has been a litigation play, a confusing one at that. Many investors and analysts were turned off from the story because of the litigation.

ATL Ultrasound and the Sonosite (NASDAQ: SONO) situation is probably more relevant. ATL Ultrasound was bought out by Phillips and spun out its handheld ultrasound division (Sonosite) in April 1998. In 18 months, SONO went up about 4 times in price. Again, SONO was spun off with no analysts, zero hype and traded close to cash value. SONO is just now starting to break into profitability five years later, yet still trades for three times its average price in 1998.

The opportunity here is 12-18 months everyone will know about IGEN, many more analysts will be on the story and the valuation will be substantially higher than it is now.

Risks and Unknowns

The first risk and unknown is the exact tax consequences of the deal are a bit hazy. One of the risks to investing before the proxy is there maybe some kind of tax implication, even for investors who buy at current prices.

However, I believe that that the tax situation will unfold as follows. For simplicity sake let’s assume you buy at $57.25 per share. The cash payment of $47.25 will not be taxed. Your cost basis on your spin-off will be $10 a share. Any increase in the share price from now until the spin-off will actually be taxed as a dividend. Since the tax spin is technically a dividend.

Let me caveat this, by saying that the tax implications will not be laid out until the proxy comes out, and that I have heard other opinions as to what may occur. I think the valuation and opportunity is compelling enough that I want to be invested before the proxy and exact details come out.

Another big business risk involves the CEO, Samuel Wohlstadter and his son, who owns a joint venture called MST(check). IGEN as far as I can tell has been funneling money to the son’s company and nothing but losses have been returned. I have further heard that the son spends a lot of time at the company. This kind of related party transactions and dealing are a risk. However, as part of the deal, Roche is putting $31 million into the joint venture and the NewCo, will own 31% of the JV, but will not be required to put in any more money in the money losing JV.

My only concern is that somewhere down the line, IGEN decides to throw the JV more money or that there are more dealings that distract shareholders or the company. It is important to know that I assign no value to the JV.

Roche has big advantage going forward with non-exclusive agreement. It has been working with the technology for five years and has had time to add in its own technology and enhance IGEN’s. Clearly, by structuring the agreement as a non-exclusive, Roche is betting that it has enough of a lead that competition will not matter. For that reason, the value of future licenses maybe less, if competing companies assume it is not worth pursing Roche.

Different Ways to Value IGEN

1) Comparable valuation

I estimate that BabyGen will have $30 million in sales next year on products unrelated to Roche (growing at 25%). I also estimate that BabyGen will generate at least $60 million in royalties from competitors and others in the field in 12-18 months. That number is 4.3% of the total amount Roche is paying IGEN. I think that is a conservative number.

Assuming $90 million in sales with a 3.5 multiple of sales plus $118 million in cash, BabyGen’s value should be $433 million, or $16 a share, a 25% gain from current prices of around $12.75. Note this includes no revenues from bioterror contracts. See number 3.

2) Potential licenses based upon Roche deal

This is one of the areas that is a big unknown but could represent substantial upside. BabyGen could easily see royalties of 10% to 20% of the Roche deal value. With a $120 million in royalties, BabyGen could have a value of $19.93 a share, or a 56% gain. One of the reasons BabyGen is so exciting and “cheap” is the potential upside and the compelling risk/reward if things go right.

3) Assumption of bioterror contracts

This is the other area that is a big unknown to investors. We know that BabyGen is working in numerous areas with numerous government agencies on bioterror.

One award, the Joint Biological Agent Identification and Diagnostic System (JBAIDS) Award will be worth $145 million. This contract has been delayed for over a year and I hear it may be announced in late October.

There really is an enormous amount of upside in estimates. Right now, I assume nothing but in two years, this number could easily be over $100 million

4) Roche and PCR

One analyst assigns value to Roche’s PCR license to IGEN. I assign no value as I’m unsure as to how BabyGen could license and use Roche’s technology. This analyst values this special PCR license at $80 million.

5) JV ownership, worth anything?

I assign no value to the joint venture, but down the road who knows, it could have some value. BabyGen will own 31% of the JV.

BabyGen is all about Risk Vs. Reward and playing the upside

One real positive is that normally with acquisitions or even spin-offs is that there is selling pressure from institutional shareholders and management. There should be no selling, as every shareholder will receive $47.25 a share in cash. So, there is no need for selling based upon liquidity. Also, the major institutional shareholders have been long time holders and are clearly believers in the technology. They are very unlikely to sell the spin-off. Add in no index sellers and you have a potential explosive situation of no real sellers after the spin-off, and all kinds of new buyers being introduced to the company, with many potential catalysts in the meantime.

As I have explained above, IGEN trades on a valuation of its cash and its product sales but little else. There is no hype or upside priced into the stock. Investors at current prices are getting almost a free lottery ticket on the real potential for homeland security/bioterror contracts, new licenses for ORIGEN and pure hype on this exciting biotechnology company. Normally these companies trade for multiples of their real potential. Here’s an opportunity to buy one before it goes to the moon.



1) Proxy Statement – This is the big catalyst. I’m estimating the proxy will come out between September 15th and October 10th. A great many investors are waiting on the sidelines for more information on this complex deal.

2) New licenses of ORIGEN, especially to competitors of Roche – This will probably not happen until the spin-off is complete late this year or early next year.
3) Contract win with government agency – A large contract could be announced in late October, early November.
4) Analyst coverage of the spin-off – Only one analyst has written up this company. After the proxy and especially after the spin-off, I expect a flood of research.
5) Any continued momentum in sales from industrial and bioterror
6) Any scare or real bioterror attack – This could cause a rigorous search for companies that would benefit from biodefense spending.
7) Increased visibility by management and PR - IGEN has been tight lipped for months surrounding the lawsuit and the acquisition. After the proxy I expect renewed visibility and access to management.
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