Illumina Stock: Exceptional Growth Marred By Contentious Acquisition (Pending:GRAL)

Investment Thesis

A regulatory investigation by the US Federal Trade Commission and the European Commission did not stop Illumina, Inc (ILMN) from completing the GRAIL acquisition in August 2021. Despite the interim measure of holding the two companies as separate entities, we fear that ILMN may face regulatory hurdles in the future, especially in the EU, where massive fines of $400M may be expected. In addition, it may also affect its future revenues in the EU, where the genetic testing market is expected to be worth $6.5B by 2027. In the worst-case scenario, the divestiture of GRAIL in 2025 or 2026 may even be warranted.

We discuss whether investors should add ILMN stock now.

ILMN Completed The Controversial GRAIL Acquisition Despite Regulatory Oppositions

In 2020, ILMN confirmed that it is acquiring GRAIL (GRAL), a company developing diagnostics for cancers. Since it was spun off from ILMN in 2015, GRAL had received over $1.9B of funding in four rounds of equity financing. The company develops the Galleri blood test, which is able to achieve early detection and localization of more than 50 cancers. In addition, the test can detect these in asymptomatic patients, which may help reduce the mortality rate moving forward.

However, the acquisition has met opposition from multiple regulatory bodies such as US Federal Trade Commission and the European Commission. The regulatory oppositions are mainly attributed to the speculation that the merged company may potentially restrict public access to genetic cancer tests, due to increased prices and ILMN’s monopoly in the market. Nonetheless, ILMN proceeded with the acquisition in August 2021 despite the ongoing regulatory investigations. The company reasserted that it will work with the US FTC to comply with the final court ruling. In addition, ILMN will maintain both companies as separate entities to comply with the EU interim measures, prior to a court decision.

Moving forward, there might still be legal repercussions moving ahead as ILMN may face fines of up to 10% of annual revenue from any potential EU sales. In September 2021, ILMN CEO Francis deSouza projected that the fine would potentially reach $400M in the Morgan Stanley 19th Annual Global Healthcare Conference. Nonetheless, the company decided to proceed with the acquisition to avoid incurring $300M in breakup fee, while waiting for the regulatory decisions in the US and EU.

ILMN has effectively worsened its regulatory relations with the EC, which may cause the company to lose out in future revenue potentially generated from the EU. The EU genetic testing market is worth $3B in 2020 and is expected to grow to $6.5B by 2027, at a CAGR of 11.6%. Consecutively, it remains to be seen if EC will rule in favor of the acquisition by 4th February 2022, despite offering concessions such as “contractual guarantees of equal and fair access to its sequencing and a commitment to drive down prices by more than 40% by 2025.” Assuming court losses after protracted proceedings in the US and EU, ILMN runs the risk of having to divest GRAL in 2025 or 2026. As a result, despite the symbiotic vertical acquisition, we are uncertain of ILMN’s prospects moving forward.

ILMN Reported Excellent Recovery Post COVID-19 Pandemic

ILMN Revenue, Net Income & Gross Profit Margin.

Pre-pandemic, ILMN reported excellent revenue growth at a CAGR of 13.99% from FY2017 to FY2019. In FY2019, the company reported annual revenue of $3.54B, representing a steady increase of 6.3% YoY. However, the company experienced a decline of 8.7% YoY in FY2020 during the heights of the COVID-19 pandemic and reported annual revenue of $3.23B.

Nonetheless, ILMN is set to report $4.51B revenue for FY2021, based on its preliminary report of $1.19B revenue for FQ4’21. It represents a massive increase of 39.4% YoY and 27.4% from FY2019 levels. FY2021’s revenue shows that the company has more-than-recovered from the COVID-19 pandemic and reverted to its previous revenue growth at an adjusted CAGR of 13.54% over the past five years, despite the fall experienced in FY2020. In addition, ILMN has consistently outperformed consensus estimates in its quarterly earnings in the past four years, except for two missed quarters.

For FY2021, ILMN reported record-breaking sales of 3.2K instruments, representing an increase of 75% YoY. In addition, the company reported $3B of consumables shipment, representing an increase of 40% YoY. Consumables and services also account for over 80% of ILMN’s annual recurring revenue. In addition, the company reported an increase of 50% for new customers in FY2021, compared to FY2020 and FY2019. ILMN commented that the significant increase in sales is mainly attributed to increased genetic testing in the oncology setting, noninvasive prenatal testing, and population genomics. In addition, there has been an increased demand for sequencing work due to the COVID-19 pandemic, with labs in 117 countries using Illumina sequencers for virus surveillance.

ILMN’s Future Looks Bright Due to Its Robust Pipeline And Collaborations

ILMN Projected Revenue & Net Income.

ILMN guided revenues of FY2022 in the range of $5.15B to $5.24B, representing a potential increase of 16% YoY. The FY2022 revenue includes the projected revenue for GRAIL in the range of $70M to $90M. Over the next three years, consensus estimates that the company will accelerate its revenue growth at a CAGR of 19.36%, compared to the adjusted CAGR of 13.54% in the past five years. ILMN is also expected to report net income growth at a CAGR of 15.93%, which is in line with historical CAGR. The global genetic testing market is worth $14.8B in 2020 and is expected to grow to $31.8B by 2027, at a CAGR of 11.6%. As a result, it is evident that ILMN holds massive potential, given its existing portfolio and capabilities in the genetic testing market.

ILMN also has multiple exciting new technology launches, Infinity and Chemistry X, which will further improve the accuracy and cost-effectiveness of genetic testing. The Infinity technology is capable of automatically producing the complete sequence of the original DNA molecules, also termed as long reads sequencing, while being compatible with its existing install base of 20K instruments globally. The Infinity technology is expected to be launched in H2’22. As a result, we expect more consumers to choose ILMN moving forward as the company has committed to delivering the platform at a 10x lower cost than other providers.

We also expect a potential upwards re-rating, assuming positive results from its multiple collaborations with:

So, Is ILMN Stock A Buy?

ILMN EV/Fwd Revenue.

ILMN is currently trading at an EV/NTM Revenue of 12.08x, in line with its 3Y mean of 12.98x. Despite its fair valuation and massive potential for revenue growth, we are unsure of ILMN’s prospects moving forward. The acquisition has generated friction as the company proceeds with its risky plan despite opposition from the US and EU regulatory bodies. In addition, the company is expected to incur a stock dilution of 11.3M shares from the acquisition.

There’s little doubt that ILMN stock is a solid stock, but we encourage investors to wait for more clarity in its legal proceedings before adding more exposure. Nonetheless, aggressive investors may still add to their portfolio if they do not mind future volatility from regulatory fallout.

As a result, we rate ILMN stock as Neutral for now.