The Next Blue Chip Stocks: Illumina Inc.

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In 1970, IBM rolled out a mainframe that could do 12.5 million calculations a second. Its price? A cool, inflation-adjusted $4.7 million. Since then, technology has advanced so rapidly that a computer capable of doing 1,600 million calculations a second cost just $550 in 2007 and one capable of doing 2,580 million calculations per second can be bought for about $250 today.

At the time IBM launched its mainframe, few imagined how integral computing would become to our day-to-day living. Skepticism over the future role of personal computers was so common that seven years after IBM launched its revolutionary mainframe, Ken Olsen, the founder of Digital Equipment Corporation, an early leader in servers, said, "There is no reason anyone would want a computer in their home." Given that the size of a computer has gone from filling a room to filling a back pocket, Olsen's pessimism seems laughable today.

But Olsen's doubt may also serve as a lesson for investors to never underestimate the possibilities of breakthrough innovations. That lesson could prove particularly valuable when applied to genomics, because if genomics proves as game-changing as the computer, Illumina may someday become a blue-chip company like IBM.

Innovating understanding
The potential of gene sequencing is endlessly intriguing. The ability to lower the cost and increase the speed of gene sequencing to a point where every person on the planet could know his or her genetic code, and the genetic code of their children (both born and yet unborn) could usher in a slate of innovation that revolutionizes healthcare.

Illumina has already made significant inroads toward making genetic sequencing mass market. The advent of second-generation sequencing machines in 2008 led to a significant drop in corresponding cost (including personnel, instruments, informatics, etc.). According to the National Human Genome Research Institute, or NHGRI, which is part of the National Institutes of Health, the average all-in cost to sequence a genome fell to less than $5,000 earlier this year from nearly $100 million in 2001. Those costs, which are paid by sequencing centers that receive funding from NHGRI, are likely to continue falling as more facilities shift to Illumina's latest sequencer, the HiSeq X Ten.

The HiSeq X Ten brings the cost per genome down to $989-$999, and breaking below $1,000 should encourage significantly more research across populations; particularly given that the HiSeq X Ten -- a system of 10 machines -- may be able to sequence 18,000 genomes per year.

Illumina's new HiSeq X Ten isn't cheap -- it costs $10 million -- but demand is already outpacing Illumina's January forecast for five customers this year. In the company's second quarter earnings conference call, Illumina reported that it had 13 customers already, buying a total of 144 HiSeq X Tens. That demand led to Illumina's revenue climbing 29% year over year to $346 million in the quarter.

But the real money may come from...
A sequencer is ultimately a machine, like a computer, so the price of Illumina's sequencers is likely to decline as technology advances. If so, sequencers may become commodities someday, just like computers and smartphones are today.

If that's true, then Illumina's real blue-chip opportunity may not be in building increasingly less expensive machines, but in leveraging the genomic information that these machines are producing.

Illumina is already moving in this direction by offering bioinformatics solutions such as BaseSpace, a software service that automates workflow prep for sequencing, provides analysis and storage of genomic data, and gives users a real time interface for charting and viewing genomic data.

If Illumina successfully embeds itself into customer's daily routine with an easy to use UI and increasingly relevant analytics, it would be reminiscent of technology bellwethers Microsoft , which locked millions of users up with its Office suite, and Apple , which did the same thanks in large part to iTunes.

But Illumina's potential expands beyond controlling the data and improving customer usability. The company also has a big opportunity as a companion diagnostic for next generation personalized medicine.

The ability to target drugs based on specific genetic markers is fast becoming reality and Illumina is positioning itself as a key cog in analyzing which patients are most likely to benefit from such tailored treatments. In November, Illumina announced that the FDA had cleared for use its diagnostic kit assays for detecting cystic fibrosis. That assay is designed to simultaneously detect 139 clinically relevant disease-causing mutations and variants within the cystic fibrosis transmembrane conductance regulator, or CFTR, gene.

In August, the company also announced a collaboration with drugmaker giants AstraZeneca , Johnson & Johnson , and Sanofi to develop a next-generation sequencing, or NGS, system for use in oncology. The collaboration's focus is on developing genetic tests that can quickly identify which patients would most likely respond to specific cancer drugs.

Fool-worthy thoughts
Illumina is the defacto Goliath in sequencing with a commanding market share of about 70%. It's not without competitors, but despite challenges from companies like Life Technologies, which was acquired by Thermo Fisher Scientific in February for $13.6 billion, Illumina continues to dominate the industry.

Illumina's leadership isn't a secret, so its stock price is sky high by most valuation metrics. However, that valuation hasn't scared off potential suitors, including Roche, which made a failed bid to acquire Illumina last year. Whether suitors are still interested is anyone's guess, but with the company's earnings per share growing 32% in the past year, investors may find that the company will be fine going it alone. No one can know with certainty if Illumina will follow IBM's path to blue chip status, but I for one am unwilling to be a skeptic.

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Todd Campbell has no position in any stocks mentioned. Todd owns E.B. Capital Markets, LLC. E.B. Capital's clients may or may not have positions in the companies mentioned. Todd owns Gundalow Advisors, LLC. Gundalow's clients do not have positions in the companies mentioned. The Motley Fool recommends Apple, Illumina, Johnson & Johnson, and Thermo Fisher Scientific. The Motley Fool owns shares of Apple, International Business Machines, Johnson & Johnson, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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