Health and Healthcare

Are Analysts Underestimating What Grail Brings for Illumina's Future Growth?

Jon C. Ogg

Published: September 22, 2020 11:16 am

When companies become large enough, they very frequently look to acquisitions for new growth opportunities. That has been the case for Illumina Inc. (NASDAQ: ILMN). The gene-sequencing leader has seen its stock come under pressure after its $8 billion acquisition of Grail. The IPO market was eagerly awaiting Grail’s scheduled initial public offering, but so far, analysts are balking at the $8 billion price tag.

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It is not unusual for an acquirer’s stock to fall on news that it is making an acquisition. What has been different recently is that many acquirers see their shares rise on the announcement of a deal. One issue causing some concern is that Grail had been spun out of Illumina back in 2016.

It is still fair to ask if Illumina’s stock has fallen too much on the announcement. After all, if successful, Grail could revolutionize how cancer is screened and ultimately how it is treated. The stock fell to $270.13 on Monday in much stronger trading volume of 7.3 million shares, after a $295.50 close last Friday. More recently, Illumina’s stock was closer to $350, and its shares visited the $400 handle in early August.

The $8 billion acquisition really translates to $7.1 billion because Illumina still had a 12% stake in Grail. The peak in Illumina’s stock above $400 in early August was seen after its second-quarter earnings fell short of expectations. Illumina also did not offer guidance for future results, and the company cited uncertainty and ongoing business disruption due to the COVID-19 pandemic.

Canaccord Genuity analyst Max Masucci maintained his Hold rating on Illumina, but he lowered his price target to $300 from $350, after noting that the company was swinging for the fences here. His note specified that likely it would be at least two years before the value generation potential of this deal can even be evaluated. That said, he also believes it is supportive of rich valuations in other cancer screening companies but he is having a hard time justifying the $8 billion price tag.

BofA Securities maintained its Underperform rating, and its price objective is down at $220. This firm does see upside potential in the out-years if the promise of Grail pans out, but in the near term, the firm is more cautious about the transaction based on the large up-front investments. The firm also cited the myriad commercial, regulatory and reimbursement challenges that will come. Also, the surprise deal underscores some underlying concerns on Illumina’s base business.

Other firms have weighed on the deal as expensive and creating uncertainty as well. These are some of the calls seen in recent days:

• Stifel downgraded it to Hold from Buy and cut its price target to $280 from $380.
• UBS downgraded it to Neutral from Buy and cut its target price to $285 from $390.
• JPMorgan downgraded it to Neutral from Overweight and cut its target to $280 from $390.
• Robert W. Baird maintained its Neutral rating but cut its target from $335 to $281.
• SVB Leerink maintained its Outperform rating but cut its target to $315 from $360.

Grail was expected to have a hot IPO after its recent filing was evaluated. Whether or not that would be an $8 billion value was still not set in stone. Grail is developing cancer testing that detects cancer at its earliest stages in proactive screening, and the goal is to help patients beat cancer long before it even starts to spread.

Grail had an impressive round of investors. Jeff Bezos invested in the company via his Bezos Expeditions personal venture capital fund. Bill Gates also invested $100 million into Grail at the same time as Bezos back in 2016.

Grail is believed to be very close to the launch of its Galleri blood screening, and Illumina’s own statement noted how Galleri is among the most promising new tools in the fight against cancer that will join the NGS platform for next-generation sequencing technology.

Illumina’s revenue growth is expected to be interrupted in 2020, but consensus estimates are calling for nearly $4 billion in revenues in 2021 and for earnings to come in just shy of $7.00 per share. The more modest $264 share price and $38.5 billion market cap generate forward multiples of about 38 times expected earnings and about 9.5 times expected sales. Those are not cheap multiples compared to the S&P 500, but that is actually somewhat modest for the likes of Illumina.

While it is easy to knock a company for making an expensive acquisition during harder times, Illumina is the leader in its gene-sequencing equipment. This company also has a history of seeing its big drops ultimately followed by longer-term recoveries to even higher share prices. If Grail’s upside changes the standard of cancer testing, then Illumina probably still will get the last laugh here. If not, it’s pretty evident how Wall Street will feel about the company spending another $7.1 billion to acquire what was previously already owned.

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