Illumina to Shake Off the Shorts

 | Jan 13, 2012 | 7:40 AM EST
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Back in September, I believed the shares of Illumina (ILMN) would trade flat to down while investors waited for clarity regarding the size of the National Institutes of Health budget. As it turns out, the NIH budget was spared the worst, but stock was just about cut in half.

Earlier this week the shares rallied on the announcement that Illumina would begin selling a fantastic new genetic sequencing machine, the HiSeq 2500. Hoping to steal Illumina's thunder, Life Technologies (LIFE) rushed out a rival machine on the same day. Both companies claim their machines can map a genome in a single day. Both machines are expected to ship later this year.

To review, Illumina has an estimated 60% market share of the $950 million genetic sequencing market -- a market that is growing in the high teens. The desktop-size next-generation sequencing machines made by Illumina and Life Technologies are taking market share from the old microarray technology, since these solutions offer much faster results. In most cases, it takes just two hours for a researcher to prepare a DNA sample, and 120 gigabytes of genetic date comes streaming out of the machine within a few hours.

If you follow these companies, it's important to watch the NIH budget. About one-third of the industry's sales come from research labs funded by the federal government. For fiscal year 2012, the NIH budget was cut just 1% to $31.987 billion. The NIH is the largest supporter of biomedical research in the world, providing funds for more than 40,000 research grants and more than 325,000 research personnel at more than 3,000 research institutions across the entire country.

In the U.S., the largest genomic sequencing effort is based at the Broad Institute in Cambridge, MA. Broad sequences more than 50 billion bases pairs per year. Overseas, China's Beijing Genomics Institute, or BGI, has become the largest next-generation genome sequencing center in the world after purchasing 128 new HiSeq 2000 genome sequencers from Illumina last year.

To recap, Illumina's HiSeq 2500 promises to sequence a genome in 24 hours. Considering it wasn't that long ago when it took 10 years to sequence the first human genome, this is a fantastic development. (The human genome has 3.2 billion base pairs. A base pair is two chemical bases bonded to one another forming a "rung of the DNA ladder.")

But, for investors, besides concern over the NIH budget, there have been worries about the slowdown in the sales of consumable reagent kits. Fully tricked out, the HiSeq 2000 costs $740,000 and uses about $500,000 of consumable reagent and chemistry kits a year. Labs typically stock up on these things so they have them on hand. (You can't really run down to the bodega to pick up an extra v2 reagent kit, now, can you?) Anyway, the new v3 kits are out, and I believe labs have begun switching over. We should begin to see a pickup in consumable sales later this year.

All that said, I believe Illumina stock can regain its momentum as labs all over the world drool over these thoroughbreds. Oxford University, for example, has partnered with Illumina and plans to sequence the DNA of 500 individuals with various genetic diseases. You can bet they will be using the HiSeq 2500. Other labs have to be envious.

Competition from Life Technologies is limited, since that company's machines are more advanced, but considerably more difficult to use. Labs generally prefer the horsepower and ease of use of the Illumina machines. So, Illumina was a heavily shorted stock. But, as the shorts cover the momentum, investors will be back to start a new sequence.

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