Is The Pain Over For Illumina?

| About: Illumina, Inc. (ILMN)

Illumina Inc. (NASDAQ:ILMN) sent shock-waves through the biotech sector on Friday after revising its third-quarter revenue guidance and then altogether pulling guidance for year-end 2011 and future near to mid term quarters.

And, as happened with Dendreon (NASDAQ:DNDN) back in August when that company also reset its near-term guidance on a grand scale, Illumina also took its most closely-related companies down with it, if not the entire sector.

The news that led to Friday's price plunge came on Thursday evening, when the company announced that third quarter revenue was going to be about $235 million, far below the estimates provided by most analysts that predicted revenue of $280 million. It further shook investor confidence when the company declined to offer future revenue forecasts.

The drop was accompanied by volume of more than ten times the normal average, and although there was a miniscule rebound from the lows of the day, there were no indications on any front that the drop will be temporary, at least not for the short term.

In fact, given that Illumina shares traded for roughly thirty dollars less than they were just over three months ago, with only $12.75 of that attributed to Friday's plunge, this news didn't necessarily sneak up on everybody. Especially in retrospect, it looks like the writing was on the wall.

What killed Illumina, according to comments released late last week, is that the company receives a large chunk of its revenue from government sources, sources that might be drying up as Western governments are on the brink of going broke.

Chief Executive of Illumina Inc., Jay Flately noted,

In the quarter, we saw what we believe to be an unprecedented slowdown in purchasing due to uncertainties in research funding and overall economic conditions, as well as a temporary excess of sequencing capacity in the market. We expect these conditions to continue through at least the fourth quarter, while the 2012-2013 U.S. budgets for [the National Institutes of Health] and other related agencies are determined.

A volatile ride should be in store for this stock, needless to say, and as investors look to take advantage of a potential rebound play, it might be smart to stay away from this one for the time being.

There's a lot of money to be made for some companies by relying on government funding to stay alive (like Avi BioPharma (AVII) has), but Illumina is too over-exposed to government derived revenue, with reports having 80% of its revenue (see here) coming from government sources.

This is especially relevant when huge government cutbacks are in store, and could be accentuated even more when the next round of elections take place. Depending on just how contract friendly the next administration is, companies and contractors who have milked the government for years might find themselves having to trim their own bottom lines as the taxpayer well dries up.

The analysts are bailing out and stating that although the revenue miss was not a surprise (see here), it was a surprise in its severity. Makes you wonder why they'll tell you now that it was no surprise, but left 'Buy' ratings on the stock as it trickled down from near eighty bucks.

There may be some short term volatility to play with as far as quick trades are concerned moving forward, but until the revenue stream is more diversified away from the government money, I'd be wary about jumping into this one.

Even though the analysts are still saying hold it - but not buy it - while admitting that there's little chance to improve growth over the coming quarters.

One to keep on the watch list, but the pain might not be over.

Disclosure: I am long DNDN.