Spinning off is easy, getting back together is hard—at least if you are trying to do it under the wary eyes of regulators on two continents.
On Aug. 16, 2021, shares of genome sequencer Illumina Inc. (ILMN, Financial) hit a lifetime high of $524.84. Two days later, the company announced it had completed its acquisition of GRAIL, a company that it had spun off five years earlier.
By the close of trading on Aug. 18, the price was down just over $12 to $510.61. The following day, the stock fell roughly $40 to $470.36. And it kept on falling. At the close of trading on Jan. 2, 2023, it was down to $202.20.
And of course, Illumina’s stock was not helped by the market-wide collapse of share prices that began in late 2021.
About Illumina
In its 10-K for 2021, Illumina describes itself as a “global leader in sequencing- and array-based solutions for genetic and genomic analysis.” Its customers include “leading genomic research centers, academic institutions, government laboratories, and hospitals, as well as pharmaceutical, biotechnology, commercial molecular diagnostic laboratories, and consumer genomics companies.”
Founded in San Diego in 1998, it has a market cap of $31.81 billion and, on a trailing 12-month basis, it had revenue of $4.69 billion. In 2021, 52% of total revenue came from international sales.
GRAIL
Biotech company GRAIL specializes in blood tests (liquid biopsies) for 50 forms of cancer, which it claims to detect before patients notice any symptoms. With early detection, patients and their doctors can get an early start on treatment, thus increasing the probability of success.
GRAIL was spun off from Illumina in early 2016, although the latter did retain a 12% stake in the new company. In 2020, Illumina announced its intention to take over GRAIL again and followed up by doing so in 2021.
The Federal Trade Commission announced on March 30, 2021 that it had filed an administrative complaint and asked a federal court to block the acquisition. According to the FTC, the deal would “diminish innovation in the U.S. market for MCED [multi-cancer early detection] tests.”
The European Commission prohibited the acquisition on the same grounds as the FTC.
An administrative law judge rejected the complaint in September 2022, ruling that the FTC had failed to prove there would be a substantial lessening of competition in the relevant market. The FTC has appealed the decision.
Illumina expected both challenges when it announced the acquisition. Regarding the FTC, it wrote in its news release, “There is no legal impediment to acquiring GRAIL in the U.S. Illumina is committed to working through the ongoing FTC administrative process, and as always, will abide by whatever outcome is ultimately reached in the U.S. courts.”
As for the EU challenge, it wrote, “GRAIL has no business in the EU, and the company believes that the European Commission does not have jurisdiction to review the merger as the EU merger thresholds are not met, nor are they met in any EU member state.”
The company also argued there were compelling reasons for the deal to go ahead. First, it would speed up availability of GRAIL’s testing to doctors’ offices and could save 10,000 lives over a nine-year period.
Second, it noted the two companies are not competitors, and the deal was a vertical acquisition. Third, the GRAIL test is available but is expensive because it is not covered by insurance. That would be reversed if Illumina owned the company.
No one yet knows how the two challenges will work themselves out, but the Illumina share price is unlikely to make any sustainable gains until this shadow is lifted.
Still, Illumina is a large-cap company with lots of other successful business interests, and should continue to make progress in the rest of its businesses.
Financial strength
Illumina receives a 7 out of 10 ranking for its financial strength, based on its interest coverage ratio (a proxy for indebtedness), its debt-to-revenue ratio and its Altman Z-Score.
Bringing GRAIL back into the fold cost Illumina $3.1 billion in cash, plus $4 billion worth of stock and other considerations. As a result, its debt has increased significantly.
Still, its interest coverage ratio of 16.16, its debt-to-revenue ratio of 0.37 and Altman Z-Score of 3.59 are all reasonable and give me no concern about its financial sustainability.
Profitability
A high profitability ranking for Illumina, 9 out of 10, is based on its operating margin, the trend of the operating margin over the past five years, its Piotroski F-Score, the consistency of its profitability and its predictability ranking.
The company’s operating margin took a hit in the third quarter of 2021, but has since recovered.
Except for that one quarter, it has been relatively consistent over the past 10 years.
The Piotroski F-Score is low at just 3 out of 9, and the predictability ranking is middling at three out of five stars. We might say the same of its consistency of profitability.
Growth
Again, Illumina scores a ranking of 9 out of 10 for growth. That’s based on its three- and five-year revenue growth rates, the predictability of its five-year revenue growth rate and its five-year Ebitda growth rate.
The chart below shows its revenue growth, which has grown consistently in four of the past five years.
Ebitda growth has been more volatile.
Five-year free cash flow took a beating in 2021, presumably because the company needed to raise $3.1 billion to buy GRAIL.
Dividends and share buybacks
As might be expected of a growth company, it pays no dividend and its share count shot up last year to cover the GRAIL deal.
Valuations
The GF Value Line, which is based on historical multiples such as the price-earnings ratio and price-book ratio, as well as an adjustment based on past returns and growth and future estimates of its performance, concludes Illumina is significantly undervalued.
The undervaluation is so deep that GuruFocus warns it might be a value trap (a stock that might collapse to nothing). However, we can discount that quickly. The company has cash and cash equivalents of $1.04 billion and ongoing, profitable operations. Its short- and long-term debts of $1.74 billion are relatively small in comparison.
The GF Value chart’s estimated value of $408.82 is almost exactly double the Jan. 2 closing price of $202.20. That suggests a lot of upside potential when (or if) it resolves its issues with the FTC and EU, and the market recovers.
Gurus
GuruFocus shows Illumina shareholders among the gurus include Baillie Gifford (Trades, Portfolio), the Vanguard Health Care Fund (Trades, Portfolio), Ron Baron (Trades, Portfolio), PRIMECAP Management (Trades, Portfolio), Steven Cohen (Trades, Portfolio), Jerome Dodson (Trades, Portfolio), Louis Moore Bacon (Trades, Portfolio), Joel Greenblatt (Trades, Portfolio) and John Hussman (Trades, Portfolio). Institutional investors own 80.34% of the company.
Insiders have a 1.92% stake, with CEO Francis DeSouza having the largest slice with 79,443 shares.
Conclusion
Illumina is a growth stock in waiting, waiting for a resolution of its issues with regulators and with the stock market as a whole.
In the meantime, it continues to be a strong performer, with excellent growth and profitability metrics.
