The Illumina Mystery

| About: Illumina, Inc. (ILMN)

Shares in Illumina (NASDAQ:ILMN) have crashed sharply for the second time in six months after another profit warning. It more than recovered last time, with the stock climbing 35% since then – an almost inexplicable rise, though expectations of a takeout and general excitement around the sequencing sector played their part.

In order for the shares to recover again, investors will have to believe management has the situation in hand and/or that a buyer will emerge. Given that a profit warning for 2017 cannot be ruled out, such belief will require great optimism. That said, the stock is remarkably resilient: out of the past six quarters, Illumina has either missed or lowered expectations four times, each time seeing its share price fall and bounce back. Perhaps it can do it again.

Yesterday’s fall of 25% came after Illumina missed third-quarter sales expectations, bringing in just $607m against guidance of $625-630m. Management said it expected fourth-quarter sales to be flat or slightly up, suggesting full year sales of around $2.4bn. Before the last profit warning in April the company was expecting sales this year of close to $2.6bn.

Seeking the Grail

The sales miss was blamed on declining demand for its high-throughput genetic sequencing machines. But management’s failure to realize that this demand would shrink is worrying.

Illumina’s HiSeq X system sells for over $1m, and as well as individually the company sells them in blocks of five or 10 at a time. It failed to close a deal for 26 HiSeq Xs in the third quarter. Management added that in the coming quarter “there are a number of large, binary deals that may or may not close.”

Currently 2017 consensus sales forecasts for Illumina are approaching $3bn, according to data compiled by EvaluateMedTech. Presumably this figure will be revised downwards as the sellside absorbs this week’s news, but as no new instruments are expected to launch until the second half of 2017 the revisions might have to be significant.

The next big launch for Illumina should be the Firefly, a semiconductor sequencing platform intended to be sold to hospitals, which management has said will launch late next year. But the really big deal is Grail, a subsidiary Illumina set up in January to launch a liquid biopsy – a test for cancer using circulating tumor DNA in the blood – by 2019.

Other investors in Grail include Bezos Expeditions and Bill Gates. When the founders of Amazon (NASDAQ:AMZN) and Microsoft (NASDAQ:MSFT) are on board, things can get pretty crazy on the stock market as retail investors, convinced that they too can be tech billionaires, pile in.

So perhaps that accounts for Illumina’s stock recovering after its repeated plunges, and excitement will slowly build again, pumping it back up this time too. Or perhaps investors will continue to hope for a deal, though it is hard to see who might buy.

Buyer?

Roche (OTCQX:RHHBY), which failed to buy the company in early 2013, has been more focused on classical diagnostics deals of late and is less likely to want to get into clinical sequencing now as it slowly becomes clear that this use of the technology is a bit of a slow-burn. Thermo Fisher Scientific (NYSE:TMO) might have been a possibility, but it went for Affymetrix in January (Thermo kicks off 2016’s medtech megamergers, January 11, 2016).

A pharma company might be interested: Illumina also has technologies that can be used for biomarker discovery and identification and selection of patient populations for clinical trials. It is not a stretch to imagine that anonymized data from patients taking Illumina’s tests could be used to develop new therapeutics.

Market saturation and growing competition ought to be predictable. But management’s failures at reading the market and the lack of an obvious buyer did not put off shareholders before. By the time Illumina’s fourth-quarter results come out its stock might be back up yet again.