Affymetrix, So Misunderstood (AFFX, ILMN)

Includes: AFFX, ILMN
by: Douglas McIntyre

Wow, have these shares been punished. Affymetrix (NASD:AFFX) where just shy of $60 last July, and now a day above $30 is about all the stock can do. But, there are a bunch of missing links here. The stock is almost certainly too low.

A lackluster Q4 05 and concerns that the company's new Mapping 500k Array Set chip may not be getting adopted as fast as planned have shaved almost $2 billion off the company's market cap.

But, take a step back. This company virtually owns the business of the development, manufacture and service of systems for genetic analysis used in the life sciences and in clinical diagnostics. This business gets more important to the drug and medical community everyday.

The relationships between genes and health are going to be a larger and larger part of the phamacuetical, medical reasearch and health industries. Affymetrix is increasing the genetic data on its "arrays" over time. In addition, the number of "arrays" on their wafers is expanding.

Complex medical conditions like asthma, hypertension, and coronary artery disease may well have a basis in genetics. Unlocking the secrets of the causes of diseases as diverse as arthritis and schizophenia may depend on the kind of products that companies like Affymetrix supplies. The research into new drugs also makes this kind of technology extremely valuable as time passes. Being able to determine drug efficiency and interaction can be greatly enhanced by the kinds of products Affymetrix produces.

The company has made some impressive announcements that appear to be excellent beachheads for new revenue. Their deal with Iconix to accelerate the drug development process by looking at the toxicological and pharmacological properties of drugs and drug research could turn into a very large business. The use of Affymetrix technology to test transplant organs for rejection without the use of biopsies should have tremendous value to the medical community and hospitals. The use of Affymetrix microarrays to test for pathogens like anthrax would seem to have broad appeal in areas like national security.

Affymetrix is also getting past the prime period of execution risk for its 500K Array Set. Will there still be adoption issues? Probably, but the majority of new product downside would appear to be behind them. I do not know if this is true for their competitors like Illunina (NASD: ILMN), who still have their next chip product introductions ahead of them.

If "personalize medicine" has a future, Affymetrix will be at the center of it. I am looking past the weak Q4 and assuming that this company could be at a $500 million dollar run rate late in calendar 2006, if things go well.

Affymetrix trades at 5.5 times sales. Illumina, which has much less share in the industry, trades at 14.2 time sales. Affymetrix's discount to a rational multiple is far too low.