Eli Lilly and Co. (NYSE:LLY) is best known as the maker of top-selling diabetes medications, including the popular Humalog insulin, but it's also a big player in cancer treatment. The company's goal is to derive increasingly more sales from cancer drugs, and it made an important step toward delivering on that goal on Jan. 7 when it announced at the J.P. Morgan Healthcare Conference that it's acquiring Loxo Oncology (NASDAQ:LOXO) for about $8 billion. The purchase price represents a 66% premium to Loxo Oncology's closing price on Friday. Here's why Eli Lilly was willing to pay up to own this company.

Progress toward precision medicine

Precision medicine that targets specific mutations in DNA to better combat cancer is a major area of drug research and development and Loxo Oncology's at the forefront of this approach.

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Loxo Oncology presented data in 2017 showing that 76% of patients with a TRK fusion gene mutation responded to Vitrakvi in 12 different types of cancer. That performance prompted Bayer AG (OTC:BAYRY) to license rights to Viktravi for $400 million in up-front cash and up to $450 million in regulatory and sales-based milestones. In exchange, Bayer AG gets 50% of any Viktravi profit in the U.S., and Bayer will pay Loxo Oncology a double-digit royalty outside the U.S.

Viktravi won a Food and Drug Administration approval in November, but it's not the only interesting drug that the company's got in its product portfolio. It's also developing LOXO-292, a highly selective RET inhibitor. 

In phase 1 trials, 52% of patients with RET-positive medullary thyroid cancer (MTC), non-small cell lung cancer (NSCLC), and papillary thyroid cancer (PTC) responded to LOXO-292, led by a 69% overall response in NSCLC.

There are an estimated 234,000 people diagnosed with lung and bronchus cancer annually, according to the National Cancer Institute, and about 4,600 of them are RET-positive. There are also about 54,000 cases of thyroid cancer diagnosed in the U.S. annually, and about 1,620 are RET-positive. There's no guarantee the FDA will approve LOXO-292 for use in these patients, but if they do, it could reach the market as soon as 2020, according to Loxo Oncology's management.

A bit further back in Loxo Oncology's pipeline is LOXO-305 and LOXO-195. A BTK inhibitor in phase 1/2 trials, LOXO-305 is designed to overcome resistance to existing BTK inhibitors that are on the market, such as the blockbuster Imbruvica. LOXO-195 is a second-generation TRK inhibitor that Loxo Oncology thinks could overcome resistance to TRK drugs, including Viktravi. 

Details of the deal

After Bayer secured the rights to Viktravi, investors wondered if an outright acquisition for Loxo Oncology was off the table. On Monday, shareholders discovered that wasn't the case.

Eli Lilly's acquisition of Loxo Oncology is straightforward. It's an all-cash deal that doesn't require debt financing, and if shareholders agree, then Eli Lilly expects to close the acquisition before the end of the first quarter. If everything goes off without a hitch, Loxo Oncology shareholders will pocket $235 per share in cash at that point.

As for the financial impact of the deal on its results this year, Eli Lilly didn't go into much detail about how Loxo Oncology may move the needle for it. However, management did say more insight will be forthcoming during the fourth-quarter earnings conference call on Feb. 13.

What's next

Eli Lilly's acquisition positions it as a leader in precision medicine, but it's far from the only company pursuing these targeted drugs. For example, Roche Holdings acquired Ingynta for $1.7 billion in December 2017 to get its hands on entrectinib, a selective TRK inhibitor that may help patients harboring NTRK fusions and ROS1 fusions. Also, Blueprint Medicines (NASDAQ:BPMC) reported intriguing results for its own RET inhibitor in 2018. 

These companies could crimp Eli Lilly's market share for precision cancer drugs, but there could be plenty of opportunity to go around, particularly if genetic research leads to the discovery of new mutation-targeting medicines that ultimately shift how doctors treat their patients.

Check out the latest Eli Lilly earnings call transcript.