Affymetrix: Directionless Business in Search of a Strategic Catalyst

| About: Affymetrix, Inc. (AFFX)

Affymetrix (NASDAQ:AFFX) is a biotech company offering gene analysis tools. It recently announced that it was recognized as the “fifth top performer among all life sciences companies on Twitter,” ranked by an outfit called Comprendia Bioscience Consulting Group. This distinction comes hot on the heels of receiving the 2011 North America Product Leadership of the Year Award by Frost & Sullivan, probably through a paid partnership program. (And as I write this, Frost & Sullivan has delivered another piece of exciting research regarding the company's products.) While perhaps par for the course in the competitive biotech environment, these releases smack of some desperation.

The fact is that Affymetrix, once one of the powerhouses of the sector, has fallen on hard times and been overtaken by companies offering novel next-generation sequencing technologies. Its revenues have been declining for 12 of the last 14 quarters; it has only recently become again marginally profitable and steadily cash-flow positive. It has tried to prevent employees from jumping ship by suing them. It is one of those companies where a buyout rumor or hope seems to circulate every other week.

Affymetrix is also almost 100% up from its 52-week lows. It is an interesting story.

CFO Barabe and July 2010 warning

In the first weeks of July 2010, the stock lost 40% after warning on its Q2 revenues. The stock had already been unable to sustain the bounce off the GFC lows of March 2009 and had been steadily declining. However, the warning should not have been a surprise since a new CFO had taken over just three months before, in March 2010.

Tim Barabe had previously been the CFO of Human Genome Sciences (HGSI) since 2006. He oversaw the HGSI stock also get caught in the crisis before the company finally struck gold in 2009. Barabe had 600,000 options or so at, say, $6-7 average exercise price. HGSI had been averaging $25 last year. He's doing okay there and doesn't need to worry about saving for retirement. He's had a good, low-profile career and Affymetrix could be a last officer position before concentrating on a couple of directorships.

When Barabe moved to Affymetrix, it was to be expected that he would want to start with a clean sheet: from this angle; the warning was perhaps logical. Some investors, such as Joseph Harrosh, took immediate advantage of the share price fall – Harrosh has since increased his stake to almost 10%. Integrated Core Strategies, a hedge fund, disclosed a position in November 2010 when the price was still stuck in the low $4s and then gradually sold. Mutual funds have also initiated positions, including recently a specialized healthcare fund, OrbiMed Advisors.

Since his appointment, Barabe is delivering what he can from a CFO point of view -- reducing finance costs, cleaning up inventories and rationalizing R&D and product expenses. His cost-cutting and write-downs have helped the company's cash-flows. Revenue, however, has continued to suffer; he can't do much about that.

2011 price action

The market remained relatively unimpressed by the operational improvements until March this year. OrbiMed's investment and okay-ish Q1 results helped the price stabilize above $5. But the market truly rejoiced only after the company announced the resignation of CEO Kevin King and the appointment of new CEO Frank Witney (effective July 1). As a Baird analyst noted, upgrading Affymetrix on the news, Witney "brings a string of successful leadership roles, many of which have ended as shareholder-favorable exits." In other words, he has a history of selling his company at good prices – in fact, he sold Panomics to Affymetrix back in 2008 at what was a great deal for him. More upgrades and initiations have followed the CEO change announcement, with price targets now between $7 and $10.

Prospects and a legal strategy

But the business is still not doing that well. Europe remains constrained and Japan, the company's target growth market, has been affected by the Tohoku earthquake. King's resignation is not a sign that there has been great improvement. Expect a lackluster Q2 with additional costs due to the management changes that also will affect Q3. The new CEO may also want to pull a Barabe and sandbag the Q2 results. The price looks frothy right now.

It could be that the new CEO is a turnaround magician. Perhaps he will also put an end to some of the sillier marketing releases. However, at this stage he should continue the one strategy in the biotech field that has worked relatively well for Affymetrix over the last years: Winning patent disputes.

After succesfully defending itself against current gene darling Illumina (NASDAQ:ILMN) in 2010, Affymetrix has gone on the offensive, suing Illumina in March 2011, claiming co-inventor status in certain of the latter's patents. The point is that the Wisconsin court when reviewing Illumina's 2010 complaint indicated that Affymetrix might have a claim to the effect that Illumina was not the sole inventor in the relevant patents. The issue of co-inventorship was at the time raised as a defence by Affymetrix, but the court eventually did not have to decide on it, instead dismissing Illumina's complaint on other grounds.

Based on the court's observations -- and probably having bought half the claim from the alleged co-inventor, Gregory Kirk -- Affymetrix now has struck back at Illumina. There is little to lose there; rather, the two patents at stake allegedly relate to some of the foundations of Illumina's business.

After selling a position initiated in summer 2010 into the recent upgrade euphoria, I will be looking for a new entry point after the Q2 results. There are two main catalysts for Affymetrix at this time and they don't appear to relate to business prospects. But any sale or the outcome of the legal strategy against Illumina will still take some time -- and I'm not sure the business results will support the price until then.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.