Last Updated on March 28, 2019 by Sultan Beardsley
From designer babies to malaria-resistant mosquitoes, a future where humans can dive into the basic building blocks of all life and manipulate it for our advantage is not too far away.
Startups, biotech giants, and research institutes from across the world have poured billions into research and development in this nascent field in recent years. There are now seemingly hundreds of different applications of cutting-edge genetic technology, but they all rely on a fundamental tool for the first few steps of their process – gene sequencing.
The leading provider of gene sequencing technology, Illumina, Inc. (NASDAQ: ILMN), could be the most critical enabler of this technological revolution. The company’s broad range of gene sequencing devices help researchers, regulators, biotechnology companies, and startups analyze the genetic data that underpins their business model.
As the epicenter of this expanding sector, Illumina has experienced tremendous growth over the past two decades. Revenue has more than doubled, from $1.4 billion to $3.3 billion, between 2013 and 2018. The company has deployed 13,000 sequencing devices across the world and helped analyze 100 petabytes of genetic data in 2018 alone.
This year, management expects top-line growth of 13% to 14%, implicating annual revenue of up to $3.8 billion. Meanwhile, the company’s market cap hovers around $44.7 billion, or nearly 12 times forward sales. Investors seem to have high hopes for further exponential growth and sustained margins over the long-term. But is this optimism justified? Here’s a closer look at Illumina’s prospects and valuation:
Growth Prospects
Data published by Allied Market Research suggest the global gene sequencing market was worth $6.2 billion in 2017 and could be worth as much as $25.5 billion by 2025. That implies a compounded annual rate of 19% growth. Not coincidentally, Illumina’s year-on-year growth was also 21%.
This means the company’s growth prospects could be in line with the rest of the industry, so long as it maintains its dominant position and the industry meets or exceeds near-term expectations.
In terms of expectations, industry experts believe the rapidly plunging costs of sequencing each genome and the expanding applications of this data are the fundamental drivers of growth.
When the genome was first sequenced in 2013, it cost nearly $100 million. Today, the cost of sequencing a single genome is barely $1,000. Illumina expects this price to fall further to $100 within a decade.
At that price point, even the average consumer can sequence his or her own genome. Illumina CEO Francis deSouza noted that “we’re starting to see DTC [Direct-to-Consumer] become a more global story than it frankly has ever been.” Companies like Ancestry, 23andMe, and Helix have expanded access and improved awareness substantially. There’s no indication that this market is slowing down.
Meanwhile, governments and companies are finding new ways to apply this data. Policymakers in America, Britain, France and Bangladesh are considering large population-genomics initiatives to improve the lives of citizens. Biotech companies are investigating liquid biopsies to detect cancer at very early stages, while others are experimenting with CRISPR technology and Immune Repertoire Profiling.
Lower costs, better awareness, and wider applications will all drive the market forward. But Illumina isn’t the only player in this growing field.
Competition
Illumina is up against well-funded and experienced rivals like BGI, Oxford Nanopore Technologies, Roche, and Thermo Fisher Scientific. Chinese leader BGI has more aggressive price targets than Illumina and expects to offer whole-genome sample sequencing in less than 24 hours and at a cost less than $300 by next year. Meanwhile, Amgen-backed Oxford Nanopore focuses on long-read sequencing, which is mostly complementary to Illumina’s short-read sequencing, but offers certain advantages as well.
The real risk for Illumina is losing its grip on the market and ceding share to rivals as the market accelerates. To mitigate this risk, the company has been investing heavily in research and development, expects to launch new products this year, and has just completed a major acquisition to bolster its competitive advantage:
Pacific Biosciences Acquisition
Illumina’s strategy to plug the holes in its technology stack involves acquisitions. It recently splashed out $1.2 billion to purchase smaller rival Pacific Biosciences and integrate its technology in its products.
“Pac Bio” as some insiders call the company, provides long-read sequencing similar to Oxford Nanopore discussed earlier. This is a critical technology because it enables clients to read longer strands of DNA to figure out if there is a pattern to errors or outliers in the genomic data.
Illumina’s offer of $8 per share represented a 71% premium over Pac Bio’s 30-trading-day volume-weighted average share price, which could mean one of two things: either Illumina has vastly overpaid or has figured out synergies in this strategic acquisition that the wider market has missed. Only time will tell. Meanwhile, investors need to consider the fundamentals and see if the stock is worth the current price.
Valuation
Currently, ILMN trades at $303, implying a price-to-earnings ratio of 55. Based on the management’s own growth estimates for this year, the one-year forward PE ratio is around 46.
Considering the fact that Illumina’s growth is closely correlated with the average growth of the industry, it’s safe to assume compounded annual growth could hover around 20% for the foreseeable future. At that rate, the PE-growth or PEG ratio is 2.3x. PEG ratios above 1x implies growth at reasonable prices.
In short, ILMN seems overpriced by conventional metrics, but investors should keep a close eye on this fundamentally brilliant opportunity in case a better entry point pops up.
Bottom Line
I believe Illumina is in a very favorable position in an exciting market. It’s business model and technology stack is a lot less riskier than biotech startups in this industry. The market and the company’s bottom-line are expected to grow at a reasonable and impressive clip for the next decade.
But investors need to be aware of the competitive risks and the hefty valuation before plunging into the stock. A PEG ratio of 2 is too expensive for me, but optimistic investors may disagree.
