Chemistry X, Infinity, GRAIL: The New Illumina Is A Buy (ILMN)

Public binoculars and Mountain Silhouettes at Sunrise. Foresight and vision for new business concepts and creative ideas. Alps, Allgau, Bavaria, Germany.

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I last looked in on Illumina (NASDAQ:ILMN) over a year ago in “Illumina: Gene Sequencing Leader In The Golden Age Of Genetics”. Since that time, its business has been humming; its near-term future looks to be better and better as it onboards its newest opportunities.

Investors looking for a technology leader in the healthcare sector should pay attention. Illumina is one to watch. I will explain.

Illumina’s most recent quarter demonstrated the strength of its base business

Illumina is a company on the move. Founded in 1998, it has a current (04/05/2022) market cap of ~$57 billion. Its 2021 revenues were $4.5 billion. It boasts a mid-teens long term core market growth. It grew revenues at 26% during Q4, 2021. It is guiding for full year 2022 consolidated revenue to grow 14% to 16% to approximately $5.16 billion to $5.25 billion.

Its traditional business, which it references as core Illumina in its 10-K, consists of three areas, consumables, instruments and services as listed below:

Illumina 2022 10-K

Illumina 2022 10-K (seekingalpha.com)

Illumina’s 01/10/2022 J.P. Morgan presentation includes the following three components of its instrument franchise:

  1. NovaSeq 6000 instruments for high throughput sequencing in clinical settings, 384 units shipped in 2021, leading to $1.3 million in consumables per instrument,
  2. Mid-throughput sequencers, more than 1,100 NextSeq 550, 1000 and 2000 sequencers shipped in 2021, and
  3. Low-throughput platforms including its MiniSeq™ and iSeq™ 100, more than 1600 units shipped.

Consumables which make up 71% of Illumina’s total revenues include its proprietary reagents, flow cells, and microarrays. Illumina’s service revenues, making up 12% of total revenue, include whole-genome sequencing, genotyping, noninvasive prenatal testing [NIPT], and product support.

With recurring consumable feedstock for its sequencers making up the bulk of its revenues, Illumina’s business has built-in resiliency.

Illumina’s pipeline includes transformative sequencing chemistry, dubbed Chemistry X

Traditionally Illumina’s sequencing has employed its proprietary reversible terminator-based sequencing chemistry described as follows in its 2022 10-K:

…sequencing by synthesis (SBS) biochemistry. SBS tracks the addition of labeled nucleotides as the DNA chain is copied in a massively parallel fashion. Our SBS sequencing technology provides researchers with abroad range of applications and the ability to sequence even large mammalian genomes in a few days rather than weeks or years.

Chemistry X is Illumina’s new improved SBS product. CEO deSouza is over the top enthusiastic on its potential to transform genetic sequencing in a positive way. He characterized it as the most significant upgrade to SBS since Illumina acquired it with its 2007 Solexa acquisition. He explained its significance as follows at the referenced 01/2022 J.P. Morgan Conference:

…Chemistry X delivers a 2x faster cycle times, 2x longer reads, and 3x greater accuracy. We have filed new IP on this chemistry and are developing a new large scale manufacturing facility to implement these groundbreaking improvements on future platforms.

Chemistry X will be foundational for all of Illumina’s future platforms setting a new standard for analysis. It is superior to all its competition. By employing Chemistry X, Illumina will offer the fastest, most accurate and lowest cost analysis of any platform.

He noted:

…By leveraging the world’s largest proprietary pipeline of SBS technology development, we engineered novel dyes, linkers, blocks and polymerases to deliver a new standard and performance. These quantum steps forward in sequencing technology will generate the cost efficiency on our path toward the $100 genome, leading to greater access, deeper sequencing, and the next wave of genomic discovery.

Chemistry X is surely intriguing. Is it real? Is it imminent? Will it be profitable? These are three questions investors have to ask about any highly touted new product. As for the first question, the answer has to be yes. Illumina has gone all out in its publicity for Chemistry X. It plays a prominent role in its:

  1. Q4, 2021 earnings call (the “Call“) narrative,
  2. referenced J.P. Morgan presentation including slides 28-29 and
  3. 03/2022 Cowen Health Care Conference.

The next question is on timing. Here Illumina has been coy. During its Cowen conference deSouza discussed the timing at some length. He refused to provide any specific timing parameters. However he made it clear that it was a near term product that would be introduced in stages.

It will be featured in all of Illumina’s new products as they come out. In response to a question as to which products will feature it and when they will do so deSouza stated:

…absolutely any new platform, you should assume it’s going to be based on Chemistry X going forward. We’re at that stage now. And then we have said that Chemistry X can be used in some parts of our existing portfolio. And so we still have that in front of us. It will generate the benefits I talked about in terms of enabling lower price points, faster turnaround times, higher accuracy. And so as you pointed out, we’re still very early in the next [NextSeq] 1,000, 2,000 rollout cycle. We’re really excited about the reaction from customers. It’s really emerging as a clinical workhorse and opening new parts of that mid-throughput segment. And at the right time, we consider whether it makes sense to introduce Chemistry X on it. But that remains a lever that’s available to us.

The third question on profitability will have to play out over time. Consumables make up >70% of Illumina’s revenue; by vastly enhancing the productivity and cost efficiencies of Illumina’s instruments, Chemistry X will open up expanded use for these instruments and concomitantly more consumables.

In response to a Call question as to whether its Chemistry X announcements risked freezing the market, deSouza was not dismissive, but close. First, he noted that no product had yet been announced, so there was nothing to freeze the market for. He then went on to explain how Illumina works with its customers as new products develop. It puts programs in place enabling:

  1. trade-ins on existing instruments and
  2. order revisions for items in backlog.

He noted overall, Illumina has “robust programs around enabling a seamless upgrade for …[its] customers”. Additionally, it is common practice for customers to elect to keep existing instruments in place and gradually move their workflow to new instruments.

Infinity is Illumina’s second key pipeline product generating near term growth prospects

Like Chemistry X, Infinity is another significant potential new growth driver for Illumina. During the Call, deSouza characterized Infinity as embodying its rethink of long read sequencing. It will enable Illumina sequencers to provide more comprehensive analysis of genetic sequences. Infinity will work hand in glove with Chemistry X. Together they maximize the utility and minimize the cost of performing challenging genetic investigations.

During the previously referenced Cowen conference, deSouza used an analogy to the iPhone in explaining the practical impact of these key pipeline technologies. Before the iPhone — phones, music players and internet browsing were separate operations performed by different instruments, making up different markets.

Following the introduction of the iPhone, one device does all three. The introduction of Infinity and Chemistry X, will have a similar impact on genetic sequencing. Previously no single platform provided optimal performance from a cost/benefit standpoint for both accurate and inexpensive short and long read genetic sequencing.

In the future with its new pipeline technologies, Illumina will discard this bifurcation of the sequencing market. It was:

…never what customers wanted, though. If you talk to them, what they said is they want a single platform that has high accuracy, low DNA input requirements, the cost profile that you can get from short reads and that’s what we’re able to deliver, right, with Infinity. We’re saying with Infinity, you’ll be able to take your existing platform. So the 220,000 [ph] instruments we have out in the field, you’ll be able to take your existing instruments and be able to scale up and down. The super short read, all the way up to 10,000.

When asked to define the percentage of its customer base which this would impact, say 15%, or 80%, deSouza declined to give a number. Instead he moved to its utility. At the high end, it will be a selling point for Illumina to attract customers interested in a long read instrument who can achieve expanded utility with an Illumina sequencer that can do both.

A bonus that lower end customers are explaining is smaller labs who hadn’t considered long reads at all. Illumina instruments, once fully enabled with Chemistry X and Infinity will open new horizons. DeSouza explained the opportunity that inbound customer support calls are describing as follows:

…smaller labs that frankly weren’t considering long reads at all. And they were saying, we just can’t afford to spend hundreds of thousands of dollars on another machine. We have a MiSeq, or we have an NextSeq or MiniSeq. But this opens up that segment. And they’re saying, “Oh, this is just a library prep on top of our existing instrument. Oh, well, that could be an interesting add.” And so I think that’s the other segment that it opens up that frankly, I was a little bit surprised on the upside to hear more about from.

In the hands of a lesser company such anecdotal reports would be less significant. Illumina has proven its ability to capitalize on its opportunities. As the leader in genetic sequencing with it top installed base, its new programs are likely to become industry standard.

Clouded by its antitrust issues, GRAIL will provide another growth driver for Illumina

On 09/21/2020, Illumina announced an $8 billion cash and stock deal to reacquire GRAIL, a company it had founded and spun off in 2016. At the time CEO deSouza explained the deal:

Over the last four years, GRAIL’s talented team has made exceptional progress in developing the technology and clinical data required to launch the GalleriTM multi-cancer screening test. Galleri is among the most promising new tools in the fight against cancer, and we are thrilled to welcome GRAIL back to Illumina to help transform cancer care using genomics and our NGS platform,… Multi-cancer early detection is better for patients, their physicians, and payors. As we accelerate our path to clinical leadership and the path to multi-cancer early detection, we will continue to drive significant value creation for our stockholders.

The deal has been plagued by anti-trust obstacles from both the FTC and the European Union. Despite these, Illumina closed the deal in 08/2021 with GRAIL remaining a separate and independent unit, pending ongoing regulatory and legal review.

Pending its investigation, the EU required GRAIL to be operated independently and exclusively in the best interest of GRAIL with commercial interactions between the two companies undertaken at arm’s length. Compliance with this order is being monitored by a monitoring trustee.

As for its business, GRAIL launched its Galleri test in 2021. Galleri can detect more than 50 types of cancer, most of which have no current screening. It was the first clinically validated, multi-cancer early detection test to be available to patients and providers.

CEO deSouza expressed significant enthusiasm for GRAIL’s potential during the call. Illumina is guiding for GRAIL to achieve revenues of $70-90 million for year 2022, primarily from its Galleri test. The discouraging fact is that GRAIL’s Q4 expenses were $131 million for the quarter, consisting “primarily of expenses related to headcount and clinical trials.”

Conclusion

Illumina’s sequencing business is a real gem. The addition of its Chemistry X and Infinity pipeline enhancements offers potential to turbocharge its growth.

Taking GRAIL’s expense load plus its antitrust risk together adds up to a costly package. GRAIL adds a high risk/high reward component to Illumina that muddies the story. In my view, it does not ruin its attraction as a long-term investment.

With a PE of >86 and its GRAIL overhang, Illumina is not for everyone. The quality of its core business, and its longer term growth potential are sufficiently attractive for me to overlook such negatives.

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