In 2003, an international scientific initiative called the Human Genome Project mapped the first complete human genome. The cost was incredible – $3 billion and 15 years of research – but it was worth it. Identifying the complete sequence of the human genome was akin to discovering the operating manual of the human body. In essence, the project proved a major milestone to a nascent field, genomics, which is dedicated to studying how our genetic make-up affects our health needs.
Since each human body has its own unique manual, individualized analysis is necessary for genomics-based research to truly prosper and impact preventative, personalized medicine. But the cost in 2003 ($300 million per run) made that dream infeasible.
In the past 15 years, Illumina has broken Moore’s Law in the cost of gene sequencing through a laser focus on digital innovation in a new method called “next-generation sequencing” (NGS). Using big data analysis and new techniques that performs millions of sequencing reactions concurrently, Illumina’s operating model has created a paradigm shift in personalized DNA services using the machines it develops.
To get a sense of how powerful digital transformation is on genomics, in 2005, a single sequencing run could only produce one gigabase (one billion base pairs) of data and cost $14 million. By late 2014, that rate had climbed to 1.8 terabases of data (1,800x increase) while the cost has come down to $4,000 (3,500x decrease). And just this year, Illumina’s HiSeq X machine broke $1,000.
To date, only under 500,000 people have had their genomes sequenced – the fixed costs (over $5 million for a high throughput machine) are still too prohibitive even for the $1,000 run. And despite Illumina owning >90% of the NGS market, academia and government research still represent about half the revenues. But as costs continue to decrease, volume should grow along with the total addressable market, which has now expanded to prenatal care and oncological diagnostics. Illumina’s business model is poised for this virtuous cycle due to digital transformation: the cheaper the technology becomes, the more likely it will be reimbursed by insurance, the better the data set becomes, leading to new peripheral fields if costs could further decline.
Digital transformation is at the heart of Illumina’s operating model, but its ability to attract human and investment capital comes from its business model. Despite being a leader in a still nascent technology, Illumina is cash flow positive – with $2.4 billion in 2016E revenues and $500 million in free cash flow. Operating margins are 35%, despite having the industry’s highest R&D budget at 20% of sales. Illumina is a rare breed of startup – a profitable, tangible business that has high recurring revenue and a propensity to internally reinvest. Its business model of two-thirds consumables and one-third equipment sales allow for this dynamic. Each new Illumina customer who buys its machines will typically spend 30-40% of the machine’s value in consumables each year. These consumables are proprietary to Illumina, so once the lock (equipment) is sold, only an Illumina manufactured key (consumable) can be used.
Perhaps what is even more exciting about this business model is an ever-expanding total addressable market. In 2014, Illumina quantified its TAM at $20 billion, but one of the greatest impact of big data gene sequencing is an emerging field called population genomics, or essentially big data analysis on NGS. Population genomics is the large-scale comparison of DNA across populations to study the genome-wide effects. These genetic studies yield important clues on locating genes underlying complex diseases, and is opening new applied fields from forensics to archaeology to transplant genomics (which helps determine the compatibility of a biological donor and recipient).
Going forward, I believe that Illumina should fully embrace vertical integration downstream into the currently fragmented market of consumer genomics (e.g., 23andMe, Ancestry.com, etc.). The next digital transformation in this industry should be the creation of vast genomic libraries. As more individuals sequence their genes, Illumina should move away from only equipment manufacturing and become the Google of genomics. So far, management has only dipped a toe with an equity investment in Helix. But if Illumina were to wholeheartedly embrace consumer genomics, it can sequence and store consumers’ DNA, then sell through an app platform offered by third-party players. Helix has already signed on partners such as LabCorp and Mayo Clinic, but a full-fledged push downstream with a continued emphasis on big data analytics could create the world’s largest sequencing laboratory.
Next generation sequencing is opening our lives to a very powerful form of preventative medicine. Imagine an ecosystem of physicians, nurses, and genetic counselors who personalize your healthcare experience. And through new analytic like population genomics, we can understand at a molecular level how illnesses come about, and discover customized drugs that minimize side effects in a way unavailable today.
- Illumina Company Presentations, IR website, Annual Reports, and other SEC Filings
- National Institute of Health
- Analyst reports from Deutsche Bank, Morgan Stanley, Cowen & Company, and Goldman Sachs