“Inside the Vortex of a Historic Windfall”

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Since the Stock Gumshoe’s vacation hiatus is just about to begin this morning, I thought I’d share a quick bonus for those of you who are not yet members of the Stock Gumshoe Irregulars — this article first appeared in the Irregulars Friday File on July 10, and it has not been updated. Daily articles will resume in this space the week of August 17 — have a great couple weeks, everyone!

This latest ad from the Motley Fool Stock Advisor that I thought I’d look at today briefly mentions one of Tom Gardner’s favorite picks, Dolby Labs (DLB), but I uncovered that pick for you way back in October of 2007, when they had just begun to use in their promos. When they find a favorite, they really stick to it.

Which is why it’s slightly surprising that when they picked a genetic assay company, they didn’t go with the old Rule Breakers pick Affymetrix — but not a big surprise, I suppose, since my memory of Affymetrix being a Rule Breakers favorite is several years old, and it doesn’t appear (based on their disclosures) to be in the portfolio anymore. No, they’ve gone with a larger competitor.

The ad is actually written from the perspective of a subscriber to the Stock Advisor, Dr. Christopher Tilmann, a “lab rat” who says he is not being compensated for his endorsement, he’s just touting the Gardner brothers because he wants to spread the wisdom that helped him back when the Gardners were in their tech-bubble heyday, with David picking out winners like Amazon and AOL and holding firm for big profits (yes, and big losses from the peak when they held many of them through the pop, though many were still profitable picks). If so, I hope Tilmann is being otherwise rewarded for his volunteer hucksterism — they’re certainly going to make some money off of him.

This latest ad is about the human genome, which means we quickly get into areas that I don’t understand at all … we can all read a balance sheet, of course, but reading a genetic map is another thing entirely. The argument is that we’re on the verge of the next real breakthrough in technology and medicine, with the cost of mapping an individual’s DNA drops from the $13 billion that the Human Genome Project swallowed to now about $50,000, and that the real revolution will come when it hits $1,000 and becomes a regular part of every doctor’s work. Tilmann says that “experts predict the $1,000 genome could be announced by 2011,” and I’ll take his word for that — of course, you can get an expert to say anything you like, but we are at least on that path.

He goes on to say that the single secret of great wealth creation is the reduction of consumer prices — in his words, “the best investments cause massive reductions in consumer prices.”

That includes bringing computers to the masses when Apple started to popularize the personal computer … streamlining assembly so Henry Ford could build cars that his factory workers could afford to buy, etc. etc.

So what does that have to do with us? Reducing the cost of mapping an individuals DNA will mean the market explodes in size, bringing riches to those who make the materials and testing equipment. At least, that’s the theory here.

Here’s a longer excerpt from the ad letter, it includes most of the clues we’ll look at …

“So if you’re interested in learning more, and being a pitbull on the pant leg of this rare $1,000 genome opportunity. I congratulate you. Because your timing couldn’t be better…

“‘June 8, 2009 — Rival scientific teams, including three in the Bay Area, are racing to devise next-generation sequencing technologies that can accurately decode an entire human genome in less than 30 minutes for $1,000.’ — San Jose Mercury News

“The company David and Tom Gardner are recommending has a position INSIDE THE VORTEX OF THIS HISTORIC WINDFALL! It’s a top seller of genetic diagnostic tools to research labs and universities all over the world… at the same time it’s rolling out announcement after announcement about genome sequencing in record-breaking times, at lower and lower costs.

“The stock has returned an astounding 1,105% over the last 5 years — a period when the S&P 500 has lost 19%. More recently, over the last 12 months… during one of the most difficult years in history for most companies… revenue at this company grew a jaw-dropping 48%.

“How is this company, and its investors, raking it in when the biggest, most powerful companies in the world are in a fight for their lives? The answer is straight ahead. But first, I should tell you why I’m so excited about a stock that’s already up this much…

“This company’s stock isn’t soaring on the promise of some pie-in-the-sky technology. Its business is already massively profitable, with revenue easily topping $500 million in 2008. You see, long before the $1,000 genome was on the horizon, this company pioneered a unique way of getting rapid, inexpensive reads on critical parts of the genome.

“And it sells the tools to do this to those who can eagerly afford them: drug companies, labs, universities and other researchers. For years, we (scientists and lab rats!) have been using these disposable gene chips and arrays by the truckload to discover the causes of disease… and why some people don’t react the same way to medicines as others.

“In other words, this company has a rock-solid business and revenue stream… one that not only supports, but also informs, its step into the era of consumer genomics and personalized medicine…

“And from what I know of their science and lab work, I believe they have the inside track to the $1,000 genome. And I’m willing to stake my reputation on it!

“‘The cost of determining a person’s complete genetic blueprint is about to plummet again.’ — The New York Times, October 6, 2008

“The New York Times goes on to say, at $1,000 it could ‘become commonplace for people to obtain their entire DNA sequences, giving them information on what diseases they might be predisposed to or what drugs would work best for them.’

“Remember how Intel and Apple set out to change the world? And as I mentioned, Intel stock rose over 45 times in value. Apple rose over 39 times in value. That’s 20% to 23% annual growth — every year for a decade and a half! And yet, they were still just small forces in a much larger revolution…

“Companies like Microsoft provided the operating systems… Netscape, the browser… Cisco, the routers and hardware… and so on. In a similar way, a handful of companies of the genomics revolution will become tomorrow’s household names — some will interpret genetic data, some will interface with consumers, others will build and sell the hardware.

“In my view as an investor, and a scientist, this company I’m telling you about is becoming the leader in a number of vital ways. And is sitting in the driver’s seat at a rare moment when a disruptive revolution unfolds and an unbelievable amount of wealth is created!”

So who are we looking at here? I think it must be …

Illumina (ILMN)

Illumina is the market leader in the gene sequencing business, according to what I’ve read, and it has gained that leadership, to some extent, by beating out their rival Affymetrix with new products, better pricing, or better distribution. That, and I can tell from their disclosures that this has been a Stock Advisor pick, which helps to confirm. Their revenue did easily top $500 million in 2008, coming in at about $617 million (about twice the sales of the dramatically smaller Affymetrix or Luminex, but quite a bit less than Life Technologies). The story for an investment thesis in Illumina is better competitive positioning, expanding margins, and sales growth, so this is, again, the tale of a growing company whose stock price is being rewarded mightily — ILMN trades at nosebleed valuations with a trailing PE of about 75, but their expected growth rate still puts the Price/Earnings/Growth (PEG) ratio favored by Peter Lynch at just about 1.5, not a screaming bargain but surprisingly low for that valuation.

Earnings in the last quarter grew at 75% while revenue grew at 36%, so absent other information that’s a good sign of improving profitability — which you would expect as you start to get economies of scale and as you drive better products to market. Their operating margins have recently been 20%, which sounds pretty impressive.

Are they a better bet than their competition? Well, that’s where I can’t really help you. They do have some exciting products — they’ll even sell you a Mac computer with your entire DNA sequenced on it for you, for less than $50,000, so clearly they’re out in front in getting this technology popularized and out to the masses.

Will they stay in front? Well, for a while folks thought Affymetrix would be eating Illumina’s lunch by now, too, but it hasn’t happened and AFFX is now an afterthought — with fast changing technology companies there’s always a chance that someone leapfrogs them on the way to that 30 minute $1,000 genetic sequencing product. That Mercury News article that the ad quotes mentions a few of the up and comers in the space, I don’t know that any of them are publicly traded yet, but it gives an idea of the kind of challenges that lie ahead.

I was watching the Tour de France this morning, and you see that the cameras watch Lance Armstrong and Alberto Contador every moment of the day, but the names that the announcers stumble over (surprise stage winner rookie Brice Feillu or new maillot jaune wearer Rinaldo Nocentini) can still win a stage or become surprise wearers of the yellow jersey. Or, for a more on-target comparison, remember when Google wasn’t yet public, and no one thought that Yahoo could be defeated atop the search engine rankings? Illumina is a great company, with a stock valuation that demands continuing dramatic growth, in a rapidly growing and changing industry — a good bet, perhaps, but I don’t know whether it will be a winning one.

It’s always interesting to look at Motley Fool picks — they tend to cover these stocks fairly well in their free site as well (and, of course, they disclose when they’re writing about one of their picks, which helps to confirm for me), and you can sometimes even get an indication of which stocks are in their stable by looking at the CAPS ranks — CAPS is their social stock picking system where members rank portfolios and stocks, and get brownie points for their success, and you’ll often find that picks from the paid Motley Fool newsletters have wildly out of whack bull/bear ratios — in this case, though, all of the major gene sequencing stocks, including Affymetrix, Life Technologies (used to be called Invitrogen) and Illumina have hugely positive bull/bear ratios despite their relatively weak CAPS rankings, which generally seems to mean that although many investors rank the stock highly, they aren’t the best investors in CAPs. That’s just my surmise, it’s a complicated system and it’s interesting to check up on it whenever the Fool touts a stock, it used to be seem like their newsletters completely dominated the CAPs rankings, but there are enough non-subscribers using the system now that it doesn’t seem as absolute.

Illumina is perhaps the strongest player in this field so far, though far from the largest (Life Technologies and many of the big pharma and lab supply companies like Thermo Fisher Scientific, Becton Dickinson, etc. also develop and sell at least some genetic mapping and testing gear and the like, though they don’t get the attention as “pure plays” and may not currently have as bit a market presence in this still relatively small business). But they, like the rest of us, are also suffering a bit with the weak economy — they expect some big spending from the stimulus to help their sales, as evidence-based medicine and federal funding for research return to favor in the federal budget, but it has been slower in coming than had been hoped.

Add in that many universities and hospitals are watching their bottom lines a bit more closely these days (both are big customers for this kind of DNA sequencing lab equipment), and it should perhaps be unsurprising that their numbers are likely to take a hit … as they will, Illumina announced a week or so ago that they would miss their projected revenue numbers for the second quarter because of lower sales, though they’re still on track for sales growth year over year, if not growth that matches their recent past.

If you’re reading up on the industry it wouldn’t hurt to start with the sources that this ad quotes — I mentioned the Mercury News article above and that’s here, Fortune and Forbes both covered the Illumina/Mac offer, and the NY Times article from last Fall that’s quoted above is here, it includes some more coverage of those startups that might be hoping to steal Illumina’s lunch money.

So — what’s your poison? Do you think Affymetrix will return to form any time soon and be the comeback kid, or are they humbled and beaten, left on the side of the road in their competition (both in the market and in the courts) with Illumina? Are the larger players with more diverse revenue streams a better bet, or are you waiting for the next winner to emerge from the biotech venture capital circus and lap them all? I see the logic of the pick, and agree with the direction of the industry … and the growth looks impressive, but I don’t know enough about them yet to pay this stiff a price for that growth — feel free to share if you’ve got an opinion.

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7 Responses to “Inside the Vortex of a Historic Windfall”


  1. What a fantastic article. After reading the Motley Fool report, I analyzed many of same stocks mentioned here, and I have to say, I think you’re dead on. Illumina, Inc is up about 1600% over the last five years and, consistent from financial records, their revenue may be up by around 35% over the past 12 months as well. Seems like a good buy.

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  2. DNA mapping is not new or exclusive to the like as ILMN. For $1000 you can get one from DCGN. DCGN despite alliances with big PHARMAs is not going anywhere but the dump. What if this high priced stock goes the same route. Losses would be relatively big. At the start DCGN was very promising. I would be cautious here and apply a stop loss.

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  3. So DNA mapping can identify what disease we are predisposed to. Should we go running to traditional MD? NOT so fast! Most of these guys don’t know about prevention. They are trained and influenced by big PHARMA to prescribe drugs to treat symptom. Those drugs may cause side effects worse than the disease.

    I would seek a doctor who is trained also in nutrition. As the father of medicine said, “let food be your medicine and medicine be your food”. It may sound baloney but it make sense to me. Yeah?

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