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Macquarie Downgrades Illumina, Citing Headwinds to Sequencing Business

NEW YORK (GenomeWeb News) – Macquarie Capital today downgraded Illumina's stock to Underperform, saying the company faces substantial headwinds moving ahead, including cuts in academic and government funding, excess large-scale sequencing capacity, and an "at best" flat microarray business.

In addition to downgrading Illumina's stock from a Neutral rating, analyst Jon Groberg lowered estimates for the San Diego company's fourth-quarter revenues by $8 million to $245 million and full-year 2012 revenues by $40 million to $1.06 billion.

He retained a 2011 adjusted EPS estimate of $1.22 while raising the 2012 adjusted EPS estimate to $1.44 from $1.39.

The 12-month price target on Illumina's stock was lowered by $3 to $27 per share.

In a research note, Groberg said that the headwinds faced by Illumina could last through 2013 and may not be fully understood by investors, "especially if there is no resolution to the Budget Control Act's scheduled automatic cuts."

The act was signed during the summer in order to conclude the US debt ceiling crisis and raises the debt ceiling while reducing future government spending.

Groberg added that he currently sees no "material upside to [Illumina's] stock in the near-term given its relatively rich valuation. We see inorganic growth as the only option for [Illumina] to attempt to bridge its growth gap but think its size makes executive more risky."

While noting that the firm has been a "remarkable success story" with a four-year compounded annual growth rate of 72 percent in its sequencing revenues, he also said that changes to the sequencing market, as well as funding challenges, excess large-scale sequencing capacity, increased competition, and Illumina's size will result in sequencing CAGR of 4 percent during the next two years.

About 80 percent of Illumina's revenues come from government and academic end markets, Groberg estimated, and because of the uncertainty in those markets, researchers may be taking steps to reduce their spending.

As that happens, the high-throughput sequencing market "appears particularly at risk. While areas such as cancer diagnostics are poised to be transformed by new molecular technologies over time, there appears to be a fairly significant gap to bridge from research to discovery," he said. "In the meantime, there is also a gap between the installed and available sequencing capacity in the market and the demand for that capacity from a research funding point of view."

For total dollars from the National Institutes of Health to sequencing to remain flat, the overall share of NIH dollars for sequencing would have to increase. "Thus, in a 'best case' scenario, we think NIH dollars allocated to sequencing will be flat going forward and that the competition for these dollars will increase," Groberg said.

Additionally, though its sequencing business has gotten the lion's share of attention, Illumina's microarray business still makes up about one-third of the firm's total business, and going forward it will be flat "at best."

Groberg also said that the company has a "bloated" balance sheet and that that along with challenges to growing its business organically "make an acquisition likely." Unlike in 2006, however, when Illumina purchased Solexa, "both deal and execution risks are [now] much higher."

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