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Since my last article analyzing Sequenom's (NASDAQ:SQNM) financials and modeling its forward performance here, the stock has trended down fairly strongly. With earnings coming out in tomorrow, I thought I would present a way to play the release by forecasting SQNM's SCMM and Products sales revenues and by dissecting its chart.

Revenue Estimates for 2013. To calculate revenue numbers for each of the two major segments of Sequenom's business, I make the following assumptions:

(1) 3% quarter over quarter (Q/Q) growth rate for number of tests performed;

(2) 2% Q/Q growth rate in average revenue per test;

(3) 10% Q/Q decline in Products revenue.

The numbers I generate based upon these assumptions will be fairly conservative. If Sequenom crushes these numbers, i.e. greater growth in tests performed at a greater charge-through rate, then the revenue numbers in the table below will be underestimates. On the other hand, if growth numbers come in below what is assumed, then the business and the stock are likely to suffer further declines.

A known problem in estimating revenues for Sequenom is the lag between performing the test and collecting revenue on it. This lag has been described by management and others as being upwards of a month at best. Thus, towards the end of a quarter, test performed in that time period won't generate revenue until the following quarter. The delay in recognized revenue for tests performed translates into lighter revenue numbers early in the growth cycle for Sequenom. I believe we are at the later stages of this early growth and the lagged revenue recognition will exercise an incrementally smaller impact.

Applying the assumptions above against Sequenom's Q4 2012 numbers generates the following revenue and tests performed estimates:

FY 2013

Q1

Q2

Q3

Q4

# of Tests

33990

35009

36060

37142

Revenue/Test ($)

$652.18

$665.23

$678.53

$692.10

SCMM ($)

$22,167.66

$23,289.34

$24,467.78

$25,705.85

Products ($)

$11,340.00

$10,206.00

$9,185.40

$8,266.86

Total

$33,507.66

$33,495.34

$33,653.18

$33,972.71

These are fairly conservative numbers and Sequenom has the chance to beat these with reasonable ease, leaving the door open to a significant run up in the stock price from its current $3.50.

One Strategy Leveraging Earnings Release Volatility. One way to hedge your bets in going long SQNM would be to sell its June out-of-the-money Puts. Analyzing the chart, while keeping the revenue numbers in mind, presents a trading opportunity.

SQNM weekly chart
(Click to enlarge)

Positives for SQNM derived from the chart are

  1. 3-day RSI is deeper in oversold territory than it has been in three years.
  2. The volume-by-price bars show support right up above $3. This area has provided support and when it has been penetrated, SQNM rebounded quickly.
  3. Volume on down days has been shrinking.

Negatives are

  1. 14-day RSI has not hit oversold territory just yet. There is still room for a little bit more weakness.
  2. MACD is still turned down and has not had a positive cross-over.
  3. 10-day moving average is about to have a negative cross-over with the 50-day moving average.

What is a reasonable risk/reward way to play SQNM before earnings? Since there is volatility embedded in options that will dissipate once earnings are released, one play is to sell its Puts. For example, the June 22nd Puts at $3 are trading at $0.17/0.21 bid/ask. One strategy would be to sell the Puts, hold through earnings and either SQNM will stay above $3 or if it dips below $3 there is enough time for it to rebound and have the options expire worthless, leaving the premium pocketed. This strategy has some downside protection built in, since SQNM is trading at $3.46. The stock would have to lose $0.46 + premium collected before this turns into a losing position. In the example above, if the Puts are sold at $0.17, we add that to $0.46 to get $0.63. This represents an 18% downside buffer before the trade turns negative.

SQNM has been known to move strongly upon earnings release. There is a chance that it could move 20% in either direction. If it moves to the downside, there is some technical support and an argument to be made why it won't stay below $3 for long - volume profile and already oversold. With ~33% of shares sold short, the conditions for a short squeeze are there as well.

I expect SQNM to bounce after releasing earnings. If it does, this trade will pocket $0.17 (excluding commissions), for a 4.9% profit.

You will need to understand your own risk tolerance and decide for yourself whether you are willing to take this trade.

Source: Leveraging Sequenom's Upcoming Earnings Volatility