Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market,” says Warren Buffet. That advice couldn’t be more applicable today as the bear market continues to hit new lows. To feel comfortable with your portfolio in the red, you need to invest in quality companies with conviction. As the market turns south, our focus has moved from “growth at all costs” to “survivability above all else.” A good management team should have made hay while the sun shined with a proposed pathway to profitability once the market turned south and capital raising becomes more difficult.
We find the right cadence for checking in with stocks we hold is about once a year. This helps remove the noise from quarterly results so that we can focus on longer-term trends or concerns. For Illumina (ILMN), some things we’re watching include:
- The GRAIL acquisition
- The long-read sequencing opportunity
- The recent dip in revenue growth
Let’s start with the last bullet point first.
Is Illumina’s Growth Stalling?
Illumina’s share price has corrected significantly, falling 50% over the past rolling year compared to a Nasdaq decline of 27%. To put that fall into perspective, you’re now able to purchase shares for less than they were trading at seven years ago when revenues were half of what they are today.
The significant drop in revenues for Q2-2020 was attributed to “prolonged closures or reduced operations at research labs” which resulted from the pandemic. Growth has rebounded nicely, but recent messaging suggests that double-digit growth isn’t in the cards for this year. Illumina cites the same old talking point every other company does when explaining last quarter’s decline in revenue growth – macroeconomic headwinds:
FY23 expected to be slightly moderated given the challenging macroeconomic environment and a launch year for NovaSeq X, wherein demand will outstrip supply.
“Slightly moderated” translates to a dismal 4-5% growth in revenues for 2022 (Fiscal 2023) which is depicted in the below bar chart (red bar represents 2022 revenues at 5% growth).
Stalling revenue growth is expected in a bear market as getting signatures becomes more difficult and companies tighten purse strings and cut research budgets. Flatlined growth is acceptable, but declining growth points to a product/service that isn’t resilient to “macroeconomic headwinds.”
There’s every reason to believe that the market leader in genetic sequencing hardware should be subjected to the same sort of stalled revenue growth that all other life sciences are experiencing, but that should pass once the bear market passes. It’s odd that the first slide on Illumina’s Investor Day 2022 deck discusses their efforts to hit perpetually moving and opaque ESG targets when there are much more important things to focus on – like the status of their GRAIL acquisition.
Illumina’s GRAIL Acquisition
What’s Up With Illumina’s Acquisition of GRAIL? was the title of an article we published just over a year ago which expressed concerns about the time, money, and energy being spent on an acquisition that was being opposed by regulators. Last month, the European Commission (EC) announced that it had completed its review of the acquisition and found that Illumina’s acquisition of GRAIL was “incompatible with the internal market in Europe because it results in a significant impediment to effective competition.” A succinct piece by MedTech Dive quotes a J.P. Morgan analyst who says it’s only a matter of time before the EC mandates that Illumina divests GRAIL:
The company also is waiting for a separate order from the European Commission requiring it to divest Grail, which it expects to receive by the end of this year or early 2023. The order would provide a specific time frame for Illumina to divest the company, likely within six to 18 months, Qin wrote.
Credit: MedTech Dive
In their latest earnings results, Illumina recognized $609 million in legal contingencies for the potential fine that the European Commission may impose on up to 10% of their consolidated annual revenues. Why Illumina chose to proceed with the acquisition of GRAIL when regulators had expressed concerns is beyond us. In a recent regulatory filing, Illumina talks about how they may be required to “divest GRAIL on terms that are materially worse than the terms on which Illumina acquired GRAIL.” Companies are looking to conserve cash while the IPO market has dried up which means Illumina isn’t in the best spot as they look for “strategic options” for GRAIL, a company that they funded as a startup, then bought back at an inflated price, then may need to sell for less than what they bought it for.
Perhaps they’ll make up for the GRAIL debacle with all the internal projects they’ve been working on such as their long-read sequencing offering, Infinity, which has now been renamed Illumina Complete Long-Reads (CLR). ARK Invest wrote a piece recently lauding the efforts of Illumina over the past several years as “nothing short of amazing,” but didn’t look upon CLR too favorably.
CLR’s workflow, however, seems to be more expensive, less performant, and more cumbersome than native long-read technologies. We expect to see more sequencing users adopt longer-range sequencing to address unknown questions and answers in the life sciences industry.
Credit: ARK Invest
That’s not surprising considering they’re holding long-read player Pacific Biosciences (PACB) which had something to say about the whole thing.
Late last month, PacBio published a blog post titled The HiFi difference – not being CLR which talks about how Illumina’s choice of names is rather ironic. The acronym CLR was once used by PacBio for their Continuous Long Reads technology that was error-prone and consequently replaced by HiFi sequencing reads. The article goes on to talk about how Illumina’s technology exhibits the same problems as it did nine months ago when PacBio wrote about how synthetic long reads do not compare to the benefits of true long reads produced by PacBio HiFi sequencing. It’s hard to believe that a $32 billion company would so blatantly produce marketing material that is “misleading” and “incorrect” as PacBio is claiming.
In summary, despite efforts of renaming things and using inappropriate comparisons, the fact remains that there is no change – true, accurate and long HiFi reads are unparalleled with giving researchers the most comprehensive, accurate, phased variant calling information while attempts with synthetic long reads fall far short of PacBio’s HiFi performance.
They then provide a chart which shows the “real” accuracy of synthetic vs PacBio HiFi which makes one wonder just how important accuracy really is when it comes to use cases.
As we said before, the scientific community will be the ultimate arbiter when it comes to deciding whether Illumina has built something worth paying for. Two products will be launched with full end-to-end workflows in 2023, so we’ll need to wait until next year to see what value Illumina’s CLR solution offers the healthcare community.
Going Long Illumina
Over the past eight years, shares of Illumina have returned just +3.5% compared to a Nasdaq return of +165%. Cynics can point to the poor performance of a growth stock, while opportunists might see just that – an opportunity to invest in a growth stock that’s been suffering alongside all other growth stocks. As Warren Buffett advised, don’t consider going long Illumina at $200 a share if you’ll lose sleep when it trades down to $100 a share. With a simple valuation ratio of seven, Illumina wouldn’t be considered overvalued, but that doesn’t mean it couldn’t fall further.
At current prices, Illumina still sits at the second largest holding in our portfolio by weighting, so there’s no reason to add shares. Assuming the massive TAM the company claims of $128 billion, they’ve only penetrated 7% of that, and should be able to capture a whole lot more given their market leadership position (estimated at upwards of 80%).
The failed acquisition of Pacific Biosciences means Illumina sees the importance of long-read sequencing and it remains to be seen if CLR will become a formidable threat for long-read firms like Oxford Nanopore and PacBio.
Illumina’s acquisition of GRAIL seems to have fallen through which means they wasted a great deal of resources as a result of consistently bad decision-making. When the dust settles and damages have been incurred, what’s the company’s plan to expand outside of their organic efforts? Illumina Ventures has quite the portfolio, so perhaps there are some opportunities being lined up.
The market has rightfully punished Illumina for their poor execution and a market leader is now trading at depressed prices with lots of potential growth in the pipeline. Once the GRAIL uncertainty is removed, Illumina may make for a compelling way to play the continued growth of sequencing.
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