While the impact of investor fear on promising biotech developmental stage companies that are moving the entire industry toward the personalized medicine paradigm is unknown, what should be known is that one of those essential road towards that paradigm is paved with cash.
The future of personalized medicine depends on understanding human genome. Over the next decade it will be critical to sequence every piece of organic matter in order to better understand the map of life. Sequencing is profitable and one company dominates the sequencing market: Illumina (ILMN).
While biotech companies’ actual sales are more resistant to macroeconomic conditions, the current investment climate calls for cash flow positive picks. The company’s Q3 acquisition of Avantome put the company in the red for Q3, but without the acquisition costs, the company still made $.15 EPS. Last quarter, ILMN made $.22 EPS. The company’s cash exceeds its debt, and the company can remain strong for the foreseeable future. In a challenging funding environment, the company’s cash flow positive standing puts them in position to be acquirers of struggling companies and discounted IP. In the Q4 2008 conference call, management said they would be “opportunistic.” With a brilliantly timed secondary offering, the company was able to raise 300 million when the stock price was in the high 80s, right before the huge October and November market slump.
ILMN has shown consistent top growth every quarter. Sequentially they have growth for the last 30 plus quarters. While the basic law of large numbers suggests that the delta will fall, 30 plus percent top line growth still justifies a large multiple. This 30 percent YOY top line growth is on the low end of estimates.
ILMN’s product line continues to grow and the company has no shortage of buyers globally. Management believes the demand for sequencing and geno-typing as “insatiable” (quoted from Q3 conference call). Most users and analysts believe that ILMN’s products (GA, iScan, and the Beadexpress) are best-in-class and have a strong leg up over its closes competitor Affymetrix (AFFX). In the Q4 call, CEO Flatley said that market share is “60 percent in sequencing and genotyping is 60 percent.” Although growing market share in instruments maybe tough when ILMN already has much of the market, consumables will be key going forward.
ILMN’s substantial instrument sales in prior quarters put them in a position to grow consumable products. While the typical model of companies is to sell the razor for nothing and charge a premium for the razor blades, ILMN has historically been able to sell both at good margins (consumable still are the higher margin product.) Going forward, they expect instrument sales to plateau and margins in instruments to decline, but consumables to raise considerably more than offsetting instruments. Throughput has also grown considerable. As the instruments continue to get faster more consumables will be used per installed base. The iScan system now produces over $700,000 consumable revenue per installed base.
With its market share and technological advantages, Illumina has the sequencing market for at least near term. Predictable consumable revenue, strong margins going forward, lack of a strong competitor means this company should be a sure bet in the short term. Longer term, Illumina looks promising too as long as it can acquire or produce a diagnostics business. With a strong cash position and progress with the Bead-Express, diagnostics maybe around the corner. In the mean time, I’ll take dominating the billion dollar plus sequencing market for a good biotech pick.
Disclosure: Author holds a long position in ILMN