2023-03-27 09:54:03 ET
Summary
- Illumina is still facing issues around its GRAIL acquisition.
- The company has seen continued uncertainty and has incurred a lot of losses with the GRAIL acquisition while the core business was performing soft.
- This double softness attracted interest from Mr. Carl Icahn looking to stir up things.
- Despite a re-rating of the shares and Icahn's involvement, I am cautious to go bottom fishing just yet.
When Illumina (ILMN) announced the acquisition of GRAIL in September 2020, I wondered if the deal was the holy grail. Illumina, widely recognized as a leader in sequencing and gene analytics, looked to "re-acquire" GRAIL in a risky and bold move, with the overhang of the deal still impacting the investment thesis here.
Back To September 2020
Founded in 1998, Illumina has been recognized as a leader in sequencing and array solutions for genetic analysis, having the potential to revolutionize healthcare, both in preventive and precision-based healthcare.
The company has been competing against larger peers like Qiagen, Thermo Fisher (TMO) , Roche and Agilent (A) , among others. The strong positioning and growth of the business attracted Roche in trying to acquire the business in a $5 billion deal in 2012, as Thermo Fisher offered as much as $30 billion in 2016, but the company kept its independence.
Besides the core business, the company has long worked on an interesting project called GRAIL which it spun out, initially selling a 20% stake in a $700 million deal.
Illumina itself was just a billion business in 2011 and ever since has steadily grown the business to $3.5 billion in sales by 2019 as this growth made that shares rallied from $50 to the $300s over the same period of time, pushing up valuations a great deal in the process. Amidst operating and share price momentum in 2020, the company announced that it was looking to acquire GRAIL in an $8 billion deal (again), with that business on the verge of going public. Illumina still held a minority stake in the business ahead of the deal attempt, as the screening tools had the promise to reduce mortality rates in cancer, which if it becomes reality would be a potentially great investment.
On the back of the deal announcement, shares of Illumina fell from $350 to $270 overnight, shedding $12 billion in value in the process, more than the deal tag. While valuations were far from cheap at 40-50 times earnings, I recognize the potential in a low interest rate environment and the intrinsic potential of the business, making me willing to consider the shares at $250 again.
Unfortunately, we never those levels at the time as shares rose to the $500 mark in 2021, but ever since have come down a long way. Shares have fallen to the $200 mark by summer 2022 as share have been trading in a relative tight range around the $200 mark.
What Happened?
If we forward to February 2022, the company posted its 2021 results which showed solid growth. The company grew full year sales by 40% to $4.53 billion (following an easy comparable for obvious reasons). Illumina posted adjusted earnings of $892 million, or $5.90 per share.
Earnings rose sharply as well from a $4.50 per share number in the year before, albeit less pronounced, as these numbers included the consolidation of GRAIL which it started to "contribute" from August 2021 onward. For the final quarter of the year, the unit generated $10 million in revenues, while being responsible for a $128 million adjusted operating loss.
For 2022, the company guided for a much more modest 14-16% growth in sales with adjusted earnings seen down to $4.00-$4.20 per share following the losses incurred with the purchase of GRAIL, which was set to contribute $70-$90 million in annual sales. In September of last year, the European Commission prohibited the purchase of GRAIL as the overhang of the uncertainty on the deal was one factor hurting the share price during the year.
Forwarding to February of this year, Illumina reported its 2022 results which came in far short compared to expectations. Full year sales were up just a 1 percent to $4.58 billion and while the strong dollar hurt sales growth by around two percent, it is only a small portion of the story in which growth fell short, with fourth quarter sales down as much as 10%. The company has seen declines in the core business, but GRAIL did not live up to expectations as well, with full year sales only reported at $55 million as a $592 million operating loss (adjusted) is very large, triggering a near $4 billion impairment charge.
The big issue is that the revenue standstill caused havoc on the margin as adjusted earnings fell to $2.12 per share, hurt by soft operational performance of the own business and the losses absorbed by GRAIL.
For 2023, the company sees sales increase by about 7-10% with GRAIL revenues seen between $90 and $110 million. Worrisome is that adjusted earnings are expected to see further pressure, seen at just between $1.25 and $1.50 per share. With the soft fundamental performance not supporting the shares, it is not surprising to see shares down to $220 per share here. This attracted famous activist investor Carl Icahn to nominate three candidates for the board of directors early in Mach while believing that Illumina should be looking to divest GRAIL.
The company countered this by stressing that it will move forward with GRAIL's acquisition plans to get all the regulatory approvals. Mr. Icahn does have a real point after the company itself decided to spin-out GRAIL in the past, and now goes huge ways to re-acquire the business and obtain all the approvals, while the core business has seen real struggles of course.
And Now?
The issues which I have with Illumina relate to the fundamental situation as the fundamental performance outside of GRAIL has been softer than expected, as the company has real challenges at hand. The market believes that the involvement by Mr. Icahn can move the needle as shares rose from the $190s to the $220 mark following his involvement.
The reality is that I doubt if Mr. Icahn is right as the company likely needs GRAIL to drive long term appeal, but the near-term revenue contribution of about 2% and huge losses of around half a billion are utterly underwhelming of course.
This makes that the situation quite troubling. The core operations show little growth and probably do not justify a 40 times multiple (pegging earnings power ex-GRAIL at $5 per share). The question is if the company overpaid for GRAIL (although reimbursement coverage could make a huge difference) as the losses incurred are serious and come at the worst time, certainly after the core operations have seen substantial weakness.
No Involvement
Despite the involvement of Mr. Icahn, I see no real safety out here, as Illumina is not cheap at a $35 billion equity valuation, translating into a high single digit sales multiple. The company clearly needs discipline from an operational point of view as management has mismanaged the entire GRAIL spin-off and subsequent purchase again. Believing fundamental support is hard to find at these valuations, I can not commit myself to Illumina here even as the share price has been re-rated quite a bit already.
For further details see:
Illumina: What Is Up With The Genes?