Illumina's Buzzing Genome Market
Summary
- The growing market of gene therapies enhances Illumina's growth prospects.
- Illumina has a strong balance sheet opening an opportunity to gain exposure to the rising market of personalized medicine without the risk of investing in biotech.
- The acquisition of Grail capitalizes on the growing market of gene therapies.
Investment thesis
Personalized medicine is the future of healthcare. Illumina (NASDAQ:ILMN) is at the forefront of the market through state-of-the-art, industry-standard gene sequencing instruments.
The acquisition of Grail opens a significant growth opportunity in the cancer diagnostic business powered by the rising number of gene-based therapies.
Buzzing Market
The world is undergoing a cell revolution that would transform healthcare as we know it, and custom-made personalized medicines are the industry's future. In September 2017, the FDA approved Novartis' (NVS) Kymriah, the first gene-editing therapy in its history. It soon approved Gilead's (GILD) Yescarta, which utilizes the same mode of action. Currently, there are more than 300 gene-editing drugs in clinical trials. As the number of gene-based therapies increases, so will the need for gene-based diagnostic tools, such as Illumina's gene sequencers.
Illumina is the leading manufacturer of gene sequencers, the tools used to detect gene mutations in our bodies. This microscopy tool is powerful, allowing scientists to zoom in on single nucleotide variations that cause many diseases such as cancer and genetic blindness.
One factor that hindered gene-therapy growth is costs. Yescarta and Kymriah cost $373,000 and $475,000, respectively, excluding hospital stay costs and pre-therapy tests and examinations. This pushed some European governments with national health service systems to refuse to introduce these drugs into their systems. Many US insurers don't cover such therapies or have high premiums barring access for many.
A promising technology called CRISPR is carrying hopes of democratizing gene-therapy by making it more affordable and effective. The novel technology helped the two scientists behind it win the 2020 Nobel Prize in a quiet, COVID-compliant ceremony that politics overshadowed during the election season. Soon gene therapy will become a healthcare standard, and gene sequencing diagnostic a must-have tool in every physician's office.
A larger market for gene therapies positively reflects on Illumina. The decreasing cost of gene sequencing as the supply chain evolves will undoubtedly help. This trend is indeed a tailwind for growth.
Lucrative Business Model
Illumina's revenues come from the sale of its equipment to clinical and research labs. Besides these sales, the company receives recurring income from the sale of consumables for its instruments, similar to the ink and printer business model.
Currently, the majority of the company's income is derived from the sale of consumables.
Source: Company financial statement
Moreover, Illumina launches new products. It enhances its technology, pushing labs that seek state-of-the-art technologies to upgrade their instruments to keep up and stay ahead in the drug discovery curve. In the fourth quarter of last year, the company launched the NextSeq 2000, which is more efficient, robust, and then the NextSeq 1000 that enables gene-sequencing at prices as low as $600. 
(Illumina product launch timeline. Source - Illumina Twitter page)
The Masked Dynamics Behind The Tübingen Study
Recently, Illumina announced a study agreement with the University Hospital of Tübingen to study whole-genome sequencing. The significance of this news is the strategic and competitive dynamics behind it.
One disadvantage of Illumina is the small sample-read of its instruments, allowing sequencing reads of only 100 - 300 base-pairs at a time. To get a structural scan of a chromosome or an entire gene made of billions of base pairs is not practical and beyond Illumina's instruments.
The academic research arena is characterized by opinion leaders that set the direction of research. Research that uses unorthodox methods or ideas has a lower chance of getting published in a peer-review journal. Such publications are the currency of academia, which is a cornerstone of the biotech industry. Gene sequencing was the primary tool used in the 1990's Human Genome Project, the government-funded landmark achievement that allowed the mapping of the entire human DNA. Since the project's conclusion, consensus fell on gene sequencing as the tool to detect mutations due to the robust literature surrounding the technology that scientists and researchers gained during the project.
Illumina profited from this herd mentality. Although many diseases result from small mutations, many involve more major alterations called structural variations, which Illumina tools can't detect. Gene-sequencing that Illumina offers can diagnose 50% of genetic diseases. Scientists are starting to realize the importance of structural variations as a cause of many genetic disorders. Because of the sample size limitations of Illumina instruments, it misses these structural variations.
Bionano Genomics (BNGO) serves this market through its flag product Saphyr, which can detect "whole genome sequences" or structural variations, which Illumina tools can't detect. Still, if you look at BNGO's financials, you'll see a struggle. The company is still unprofitable, and despite being in operations for more than two decades, it only commercially launched its product in 2017. Since then, it underwent a technical default on its loans and received a notice of delisting. This is perhaps why Illumina didn't enter the structural variation market at an early stage and is only doing it now through its research agreement with the University Hospital of Tübingen. The market wasn't ready for structural variation tools. Illumina was making the financially sound decision of following demand instead of the other way around, playing it safely and by the book. When asked about the next product launch during the SVB Leerink Global Healthcare Conference, Sam Samad, Illumina's CFO, stated
We really announce product launches when the market is ready for our products, when the market is ready for, whether it's the next platform, the next price point, the next innovation
The market seems ready for Illumina's whole-genome sequencing, as demonstrated in the rocketing share price of BNGO, which increased %1650 in the past three months despite its financial shambles.
The Grail Acquisition
In 2019, Illumina announced the acquisition of Grail, a clinical diagnostic instrument manufacturer that provides cancer diagnostic solutions using gene sequencing. It is a type of corporate expansion that financials call vertical growth, going up or down the supply chain. Grail has an up-and-coming technology and affordable cancer detection tool that opens an opportunity to make cancer scanning a standard of care. Currently, only five types of cancers are included in standard care guides, namely because the others have a balance of rarity and high cost of detection. The democratization of cancer tests has the potential to save millions of lives through early cancer detection, a proposition that fuels Grail's financial growth potential.
Company Financials
Last year, Illumina sales decreased by 9% from $3.5 billion to $3.2 billion due to the impact of COVID, as research labs postponed non-critical research and lower diagnostic demand as people chose to wait for necessary tests. This is a temporary blip in the company's growth trajectory.
I believe that the healthcare market developments will enable Illumina's growth in the coming quarters. Net income margin was lower due to non-recurring expenses related to the Grail acquisition.
The acquisition of Grail will cost $8 billion paid by a combination of cash ($3.5 billion) and shares ($4.5 billion). I don't see any considerable effect on Illumina's financial health, especially that there is no debt involved in the transaction. Despite the impact of COVID, the interest coverage ratio is 13x, meaning that the company generated operating income 13 times its interest expense. The company is implementing a share repurchase program that is also accommodative for the share price.
Risks
The company faces intense competition from 10X Genomics (TXG), Thermo Fisher Scientific (TMO), and Bio-Rad (BIO), and others. To maintain its leading position, Illumina must invest heavily in its R&D. The free cash flow, which measures the company's cash flow after necessary capital expenditure, is $692.5 million. From my understanding, Illumina invests around 30% of cash from operations to maintain its competitive advantage. Any changes in technological dynamics can have a detrimental effect on shares. A perception of the weakening technological advantage is enough to send the shares lower. This is not uncommon in the biotech industry, so manage your exposure accordingly.
Moreover, the Grail acquisition's benefits will depend on a successful introduction of a new technology to the market. The pace of adopting a new standard of care in the healthcare industry is time-consuming. Educating physicians and communicating with standard-setting bodies is costly and time-consuming. A prolonged process might frustrate the company's investor base, sending shares lower, so again, be prepared.
Summary
As personalized medicine becomes mainstream, so will the need for gene-sequencing tools to diagnose patients with genetic diseases, boding well for the company's growth prospects. The acquisition of Grail also capitalizes on the growing demand for gene therapies.
The balance sheet's strength, combined with favorable trends in the healthcare industry, makes Illumina an excellent investment for investors wishing to gain exposure in the buzzing biotech market without the risks associated with investing in drug-development companies.
This article was written by
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