In an entirely expected, yet still ringing declaration, Illumina (NASDAQ:ILMN) recently announced its decision to divest Grail, its cancer diagnostics business. Grail originally spun out of Illumina in 2016 and was then re-acquired by ILMN in 2020 for a staggering ~$8B. While the announcement came as no surprise given court decisions around the anti-competitive elements of the acquisition, overall investors’ sentiment and recent ILMN leadership change, its impact on both markets – the sequencing market as well as the cancer diagnostics market – has yet to fully materialize. We would like to share some analysis of this event and predictions on what may happen next.
Why was ILMN, a DNA sequencing company, willing to pay such a huge sum for Grail, a young but growing diagnostics business that they spun out only several years beforehand?
From our perspective, the 2020 decision made by ILMN signaled a strategic shift acknowledging the increasing competition and eventual commoditization of their core business in genomic sequencing. ILMN has been holding a dominant, some might say monopolistic, position in the sequencing market. However, with new competitors (e.g., Ultima [an aMoon portfolio company], Element, MGI) emerging and openly declaring intentions to disrupt this market through dramatic price reductions, ILMN began looking for alternative growth engines. With much of investor attention shifting to commercial use-cases of DNA sequencing, ILMN opted for a familiar route, which also represents the holy grail of the diagnostics market – blood tests for early detection of cancer (“liquid bio”).
So, what went wrong?
Turns out diagnostics is an entirely different ballgame. For a diagnostic business to mature, it needs to sponsor large clinical trials with limited visibility into future FDA approvals or commercial reimbursement, which in turn leads to cash flow negative businesses with unclear and lengthy paths to profitability. This proposition may have been acceptable three years ago, but in today’s public markets, a cash-bleeding business comes with a devastating overhang. Furthermore, by going into the use-case business, Illumina effectively entered a completely different target market, competing with its own sequencing customers, which in turn saw more optionality coming into the market from emerging players. This move stands, for example, in direct contrast to Thermo Fisher’s (NYSE:TMO) recent acquisition of Olink (NASDAQ:OLK), which expanded its commercial offerings to a market it already serves with a new, state-of-the-art technology platform. From our perspective, it’s therefore no surprise that ILMN shareholders looked for an opportunity to divest this $8B acquisition.
Now that Illumina declared it is going back to its roots, with a decision to double down on its core sequencing market, what are the implications for that market? And what does it mean for Grail’s market, in which we have been active investors?
In terms of the DNA sequencing market, we believe Illumina’s message is that it will not give up their dominant position without a fight, and that it is going to direct its extensive resource base to win and grow. As the incumbents in the market, it is well positioned to make aggressive moves to win more business by competing on price and service. For newcomers, it calls for a re-evaluation of differentiation and competitive strategies, and a need for a long-term view of customer acquisition and growth. This intensification of competitive forces is primarily positive for customers of DNA sequencing – increased competition will encourage faster reduction of prices with increasing service and performance quality.
For liquid biopsy companies, we are anxiously awaiting the terms and details of the Grail divestment deal as it will set the stage for how markets value such liquid biopsy companies. While we do not expect the market value to be anywhere near the $8B originally paid by ILMN, the “who and how much” will be meaningful to the space. We continue to observe remarkable advances – both genomic and non-genomic based – in the clinical validity and utility of liquid bio tests to potentially reshape how care is delivered, what it costs, and even how it is invented.
To be sure, we don’t anticipate an acquisition of Grail by one of the large Tools & Diagnostics companies, primarily because the business is still far from profitable and remains closely tied to ILMN. We do believe there will be potential interest from private healthcare investors or even tech companies given the amount of data Grail has been producing on large populations. The option of a public spinout is also technically feasible, although the market’s current lack of appetite for non-profitable companies will undoubtedly cool ILMN’s enthusiasm for a potential valuation at a fraction of the previous purchase price.
ILMN has focused on inorganic growth opportunities for many years. Today’s ILMN is essentially built on the technology attained through the acquisition of Solexa in 2007, an acknowledged win for the company. The recent Grail divestiture is shaping up as a potential glitch in their strategy, but the story for both companies, and the exciting markets they operate in, has yet to unfold.