Carl Icahn (Trades, Portfolio) is one of the most iconic activist investors or “corporate raiders” that has ever existed. Despite being 87 years old, he is still very active in the market. His latest target is Illumina Inc. (ILMN, Financial), a genomics company which he recently launched a proxy battle against.
In this discussion, I will break down this battle with Illumina and determine whether or not Icahn can generate greater value for shareholders.
What does Illumina do?
Illumina is a leading DNA sequencing company. Headquartered in San Diego, its main products focus on gene sequencing by synthesis, which involves breaking the DNA molecule into smaller segments in order to create a DNA library or blueprint.
Now this is not just for scientific curiosity, as there are many real-world benefits, including the ability to predict which genetic diseases an individual is prone to and tailor treatment accordingly. In extreme cases, this technology could be used to identify which genes would cause a genetic-based disease and remove them before a child is born, effectively creating so-called “designer babies.”
Why this could be a game changer
Often, great technology has a tipping point into mainstream adoption once its costs fall below a certain level. This is exactly what we are seeing in the gene sequencing industry.
After being launched in 1990, The Human Genome Project took 13 years and a staggering $2.7 billion to complete. In 2007, a pioneer in the DNA sequencing space, James Watson, was the first person to get his genome sequenced for slightly less than $1 million. However, since that point, the cost of gene sequencing has fallen to just $200. Illumina has a new machine that aims to bring the cost down to as low as $100.
This is a game changer as it effectively means the total addressable market for gene sequencing could be expanded to virtually everyone on the planet in a best-case scenario.
Grandview Research says base industry reports indicate the genomics industry is worth a staggering $28 billion today and is forecasted to grow to $95 billion in value by 2030.
Icahn battles Illumina
Given Illumina’s prime position in the DNA sequencing industry and the aforementioned tailwinds, one would expect its share price to be booming. However, since August 2021, its stock has been hammered by nearly 60%.
Icahn believes this is partially due to poor management and has launched a proxy battle as a result.
In the first quarter of 2023, the activist investor purchased 430,000 shares of Illumina, which traded for an average price of $210 each.
According to my estimates, this gives Icahn less then 1% ownership of the company, which is hardly enough for a takeover. However, this has not stopped him from writing a series of open letters to shareholders. In these letters, Icahn discusses the “value destruction” and “heavy volume of complaints” against the company's current management team.
In one specific case, Icahn references the example of Illumina spinning off Grail in 2016, which aimed to focus on developing blood tests for early-stage cancer. The strange thing, in this case, was Illumina then reacquired the company in 2021 for approximately $7 billion dollars. If things could not get any more controversial, in April, the Federal Trade Commission overturned a judge's decision to approve the deal and Illumina has been ordered to “unwind it,” according to Bloomberg.
The real question on shareholders' minds is: Did insiders make any substantial sum from spinning off Grail and then reacquiring it?
According to an estimate by NONGAAP Investing, a specialist in corporate governance, this value could have been between $500 million and $1 billion, which is substantial.
In Icahn’s letter, he points to the “lack of transparency” exhibited by Illumina CEO Francis deSouza and the incumbent directors.
Icahn even went as far as to suggest a law firm or forensic accounting team should investigate. He referenced the largest shareholders, which include Vanguard, Blackrock and Baillie Gifford (Trades, Portfolio), and suggested they “demand an immediate and transparent inquiry.”
In order the solve the governance issue, Icahn has launched a director contest and urged shareholders to vote. This would include replacing three of Illumina’s incumbent directors with individuals Icahn believes to be "more qualified, independent and motivated."
Challenged financials
Illumina reported mixed financial results for the first quarter of 2023. Its revenue of $1.09 billion declined by approximately 11% year over year, but still beat analysts' forecasts by $20.68 million. However, this decline is a far cry from the strong growth rates of over 77% reported in 2021.
The company also accomplished key product milestones, which included the shipping of its anticipated NovaSeq X systems and its complete long read technology. These products strengthen Illumina's position with regard to high throughput genome sequencing.
The orders for its NovaSeq X series reached over 200 from a diverse international customer base, of which approximately 40% were derived from clinics.
Its Genetic Disease Testing segment also performed well, with shipments growing by 7% year over year.
Many health insurance companies are also moving toward including genome sequencing as part of their policy, which should act as a strong tailwind for Illumina. For instance, in the first quarter, Managed Medicaid added 3.8 million people with whole genome sequencing coverage.
Illumina’s revenue was held back by a 19% decline in its consumables shipments related to Covid-19 surveillance. Overall, China-based revenue fell by 28% year over year to $91 million, which was driven by the hard lockdown disruptions.
Moving on to earnings, the company reported a $65 million loss in operating income, which was worse than the positive $135 million reported in the prior-year quarter.
A positive is management has announced plans to reduce its expenses by over $100 million in 2023. This is expected to boost its non-GAAP operating margin to 25% in 2024 and 27% in 2025, which would be fantastic.
The business still has a robust balance sheet to continue to invest with $1.5 billion in cash and short-term investments. Illumina does have total debt of $3 billion, but is manageable due to around $1.5 billion of it being long-term debt.
Valuation
Illumina trades with a price-sales ratio of 7, which is 45% cheaper than its five-year average.
The GF Value LIne indicates a fair value of $382 per share based on its historical ratios, past financial performance and analysts' future earnins projections. Thus, the stock is undervalued at the time of writing.
Guru interest
As mentioned, Illumina traded at an average price of $210 per share during the quarter, which is slightly cheaper than where the stock traded at the time of writing.
Ray Dalio (Trades, Portfolio)'s Bridgewater Associates also bought 3,415 shares at a similar level, as did Mario Gabelli (Trades, Portfolio) and Paul Tudor Jones (Trades, Portfolio).
One of Illumina’s largest shareholders, Baillie Gifford (Trades, Portfolio), trimmed its position by around 10%.
Final thoughts
Illumina has an immense market opportunity and its technology for gene sequencing is best in class. The only issue could be its management, which Icahn aims to oust in his usual confrontational style. If shareholders vote for Icahn’s suggested candidates, this has the potential to unlock greater shareholder value.
In the short term, however, I do expect a rocky road, so investors should expect quite a ride.
