Carl Icahn and Illumina Square Off Soon. The Stakes Are High.

Its messy $7.1 billion acquisition of early cancer detection company Grail, however, has shaken investor confidence in Illumina and, perhaps, in the company’s management team. Illumina shares fell 63% between its announcement that it had closed the Grail acquisition and the day a Wall Street Journal article exposed Icahns’ proxy war. 

The

S&P 500

is down just 14% over the same period, while the

SPDR S&P Biotech ETF
(XBI) is down 39%.

At a shareholder meeting on May 25, Illumina will report the results of a closely-fought proxy battle between company management and Icahn, who is hoping to elect three members to Illumina’s board. Hanging in the balance is the Grail acquisition, the fate of Illumina CEO Francis deSouza, and the future of Icahn himself, who has found himself increasingly embattled in recent weeks, facing not only an attack from a prominent short seller, but also a federal investigation.

It has all the makings of a high-stakes Wall Street drama. Here’s what you need to know to watch it unfold.

What does Illumina do?

Illumina is by far the most dominant player in the field of gene sequencing. Its machines can decode the DNA or RNA of any living thing. Illumina’s great innovation has been in dramatically cutting the cost of sequencing, which has broadened access for researchers and opened the door to a range of medical uses.

What went wrong with the Grail deal?

Illumina’s deSouza took a major risk in the middle of 2021: He closed his company’s acquisition of Grail without waiting on approval from antitrust regulators in the U.S. and Europe.

Now, it’s looking like that gamble might blow up in his face.

The idea behind Grail’s product is extraordinary: What if everyone over a certain age could get a blood test every year that would detect virtually any cancer early enough to successfully treat it? It sounds a bit like Theranos, the blood testing scam that raised more than $700 million before collapsing into a burning pile of indictments, but this test actually works.

Illumina actually spun Grail out in 2017, then announced in 2020 that it was buying it back. The Federal Trade Commission, in March of 2021, raised an objection: Since Grail and its competitors need to run their tests on Illumina’s machines, Illumina’s ownership of Grail could stifle competition. European Union regulators raised their own objection shortly after, claiming jurisdiction even though Grail had no business in the EU

Instead of waiting for a resolution of the two regulatory challenges, Illumina simply closed the acquisition in August of 2021. The company said it couldn’t wait any longer or the deal would expire, but the maneuver was both startling and risky, and regulators in the U.S. and the EU have since told Illumina to sell Grail.

Illumina is fighting both orders, and while it might prevail in the U.S., a win in the EU seems less likely. Meanwhile, the company has already put aside $458 million to pay fines in Europe related to the early closing of the deal.

When did Icahn get involved?

Carl Icahn is perhaps Wall Street’s best-known activist; famous for taking small stakes in companies and advocating for board shake-ups. Icahn’s interventions have often resulted in the departure of his targets’ CEOs, most recently last year, when

Southwest Gas

(SWX) replaced its chief executive after settling with Icahn.

Icahn’s great gift is in sniffing out investor’s discontent, and in Illumina he scented an obviously unhappy investor base, frustrated by the steep drop in the value of their shares in the midst of the Grail imbroglio. According to a securities filing from Illumina, Icahn’s involvement came as a surprise to Illumina in mid-February, when his company asked for the forms it would need to propose directors to the Illumina board.

At first, Illumina tried to come to terms with Icahn. In early March, deSouza, and Illumina board chair John Thompson traveled to Florida for a meeting at Icahn’s office. At the meeting, Icahn said he would not support any nominees aside from his own, according to a securities filing by Illumina. Icahn told the Illumina executives that he “would not even support Jesus Christ” for the Illumina board, only his own people, because “my guys answer to me.”

On March 8, Icahn offered a settlement: He would get two of his nominees on the board, plus sign-off power on a third, independent board member. The Illumina board countered, offering Icahn one board seat and approval of another independent board member. Icahn rejected the counteroffer on March 9, and days later his campaign became public with a Wall Street Journal report.

What does Icahn want?

Icahn wants three board seats for his associates, plus the removal of deSouza and Thompson. He also says Illumina should sell Grail, and that the company should not have closed the Grail acquisition without regulatory approval.

Beyond that, his program is a bit vague. It’s clear that Icahn is tuning into a general discontent with the Grail acquisition: In a presentation to Illumina investors, he called the decision to close the deal “egregious and inexplicable.” In a separate letter, he writes that he believes the company should focus on growing its core sequencing business. His dozen or so letters to Illumina investors raise other issues, as well, though some of his claims are hard to parse.

Icahn did not respond to an inquiry from Barron’s.

What are the stakes for Icahn?

In the midst of the Illumina campaign, short seller Hindenberg Research dealt Icahn a body blow, issuing a report that claimed that Icahn’s holding company, the publicly-traded

Icahn Enterprises

(IEP), had inflated the value of some of its assets. Hindenburg, which disclosed having taken a short position in Icahn Enterprises, said the company’s large dividend yield isn’t supported by its cash flows, claiming that it’s funding the dividend by selling shares.

Icahn hit back, defending the valuations and saying that, due to the complexity of the company’s structure, its actual cash flows were bigger than they appeared. Still, Icahn Enterprises shares are down 32.5% since the Hindenburg report.

More bad news: Icahn Enterprises reported a loss of $270 million in the first quarter of 2023, and disclosed on May 10 that federal prosecutors had requested information from the company the day after the Hindenburg report was published.

In other words, Icahn needs a win. His business relies on the power of the Icahn name; on his ability to pick up the phone and send shivers through a boardroom. A victory over Illumina would show that Icahn still has bite, even with the short sellers nipping at his heels.

Is Icahn going to win against Illumina management?

He might. Icahn got a big boost last week when Glass Lewis, a company that advises investors on proxy votes, threw in with the Icahn slate, recommending that investors vote against board nominations for deSouza and Thompson, and for two of Icahn’s three nominees. In its report, Glass Lewis said that, while Icahn’s case isn’t convincing on all points, his central criticism of the Grail deal is compelling. Glass Lewis also knocks deSouza’s compensation, calling it “substantially misaligned.” (He received total compensation of $26.8 million in 2022, mostly in the form of stock options.)

“Investors have ample cause to hold the incumbent board, including CEO Francis deSouza and board chair John Thompson, directly accountable for the myriad risks, costs and uncertainties which continue to be associated with Illumina’s questionable determination to close the GRAIL transaction,” Glass Lewis’s report concluded.

A report from another proxy advisor, Institutional Shareholder Services, was more equivocal, recommending that shareholders vote for one of Icahn’s three nominees, and saying that a removal of deSouza would be “excessively disruptive.”

Illumina’s big investors, meanwhile, have been keeping mum, at least in public. The company’s largest institutional shareholder, Baillie Gifford, declined to comment in response to a query from Barron’s.

How does Illumina respond to these critiques?

Illumina has defended its decision to close the Grail deal without regulatory approval, saying that the merger contract would have lapsed had it not acted. What’s more, it says there’s no way to sell Grail more quickly than the company already is: It has already begun divestiture work, but says it must let the litigation play out because the “potential value of GRAIL to Illumina’s shareholders outweighs the costs” of challenging the regulatory actions, according to a May 12 securities filing.

Illumina says in the same filing that it is “not satisfied with the current share price” either; that it is focused on improving performance; and that Icahn’s nominees have presented no viable strategy. The company says that the directors proposed by Icahn, two of whom are current Icahn employees and one of whom is a former Icahn employee, will harm the core Illumina business with their short-term focus and lack of relevant experience.

As for deSouza’s compensation, which both Icahn and Glass Lewis have knocked, the company says that the bulk of the 2022 compensation consisted of a “one-time special grant of stock options,” tied to the release of the new NovaSeq X machine. Importantly, the options only have value if Illumina’s share price exceeds $330.25; the stock is now trading at $203.

“The one-time grant was all performance based,” says Gary Guthart, chair of Illumina’s board’s compensation committee and CEO of

Intuitive Surgical

(ISRG). “The value of that is they’re not worth anything if you don’t create value in the company over time.”

Still, Guthart acknowledged Glass Lewis’s concerns. “There are some good recommendations in our conversations with shareholders and with the proxy advisors as to modifications to our compensation program that we will absolutely consider going forward,” he said.

What happens if Icahn wins?

With three trustees in place, Icahn wouldn’t have enough votes to remove deSouza, though the CEO’s position would likely grow untenable. As for the Grail deal, it isn’t clear how quickly a sale actually could happen, with litigation ongoing in multiple jurisdictions.

And what if Icahn loses?

Then deSouza would be saved, for now, but he would still be facing an even more formidable problem: How to drive the company’s share price back up, with the Grail litigation unresolved? Illumina says it believes it can resolve the legal processes by early next year, and that if it wins, it won’t need to pay the $458 million fine. If not, it isn’t clear how the company hopes to rebuild the value destroyed in its pursuit of Grail.

Write to Josh Nathan-Kazis at [email protected]