Reflections: Illumina

All investment strategies have the potential for profit and loss, your or your clients’ capital may be at risk.

So concluded our first analysis of Illumina, the genome sequencing company, written in March 2011. As surprising as those words may appear for any risk-averse readers, this is our Long Term Global Growth (LTGG) investment process in action. Despite high odds of failure, our fundamental research led us to believe there was a small but still attractive chance that the fledgling genome sequencing market would flourish over the subsequent decade – a market in which Illumina would retain dominance and quintuple in value. We posited that genome sequencing would be central to revolutionising healthcare, making it less expensive, more personalised, and more effective in preventing disease.

We therefore made an initial holding in Illumina for the LTGG portfolio in the summer of 2011. The following year, we took voting action to fend off a takeover by Roche, which attempted to buy Illumina opportunistically at a price which we believed materially undervalued the long-term potential of the business. Sure enough, in the years that followed, the cost of DNA sequencing dropped exponentially thanks almost entirely to Illumina’s relentless innovation. This enabled its genome sequencing machines to move beyond the academic realm of university research institutes into clinical laboratories, thereby expanding Illumina’s market opportunity. At a near monopoly, the company was able to dictate the price and control the innovation curve of the entire genomics industry.

Signs of the coming healthcare revolution that we had imagined in our early analysis were visible to all during the Covid-19 pandemic. Within a week of Chinese authorities notifying the World Health Organisation of several cases of pneumonia in Wuhan in late 2019, Illumina’s machines were used to sequence the virus’ genetic code and identify it as Covid-19. This allowed Moderna (also held in the LTGG portfolio) to develop a vaccine within days. This speed was unprecedented; historically, developing a vaccine could take up to a decade.

Thus, from a market capitalisation of around $9bn at time of our initial purchase in 2011, Illumina reached over $75bn by mid-2021 – an eight-fold increase. It became one of the largest holdings (often in excess of 8 per cent) in the portfolio for several years.

However, despite the phenomenal structural shifts underway in healthcare and Illumina’s spectacular growth, we began to detect signs of trouble brewing in the company.

Specifically, we were concerned about two strategic decisions taken by the CEO at the time, Francis deSouza: firstly, to repurchase GRAIL, and secondly, to close the deal before full regulatory approval. We questioned both these decisions with him during meetings in 2020 and 2022, respectively. For background, GRAIL, a business that develops non-invasive liquid biopsy tests that screen for multiple types of early-stage cancer, had been initially spun out of Illumina in 2016.

Additionally, our reviews of Illumina and other companies in the genome sequencing market led us to become increasingly concerned about the rising competition facing Illumina. Despite being the global leader in its field, growth decelerated dramatically in recent years, at least partly due to a lack of internal innovation. Given our unease about the possible consequences for our long-term investment thesis, we reduced our holding in late 2022.

In the months that followed, we met several times with various board members and executives at the company to discuss our concerns around leadership and growth. Other shareholders also started to push for change. Ultimately, the CEO and Chair stepped down and new directors joined the board – a belated recognition of what had become a poorly run business. Still, we remained deeply concerned about the longer-term erosion of Illumina’s competitive position. We therefore further reduced and eventually sold the holding from the LTGG portfolio in late 2023. While Illumina nevertheless generated a (modest) positive contribution to LTGG portfolio performance during our holding period, its legacy is a far cry from its former multi-bagger success.

Were we too slow to sell? Or too quick? Time will tell. A more important question is: Did we sell when we did for the right reasons? To answer this, let’s return to our LTGG investment process. On paper Illumina should have one of the strongest growth rates in the portfolio – with less than 1 per cent of humans sequenced, a near-monopoly position, and strong public and private health tailwinds. Recognising that the most dangerous risk facing the LTGG portfolio is that of missed opportunity, we patiently engaged with the company over several years based on the probability that the core business would prove its strength and that the situation with the poorly executed acquisition of GRAIL would ameliorate. But question marks remained on both. When answering our 10 Question Stock Research Framework that we use to analyse all stocks on a pre-buy and post-buy basis, it became clear that our investment thesis for Illumina had become materially damaged in areas such as growth rate, margins, management, and capital allocation. We therefore did what we have been entrusted to do – we followed our investment process.

All holdings, regardless of their tenure, must continue to justify their positions in the portfolio. Competition for capital remains intense. The proceeds from our reductions and sale of Illumina have been recycled into a diverse bunch of other holdings – all of which are addressing vast market opportunities and delivering double-digit growth. Other holdings at the forefront of the healthcare revolution, such as Intuitive Surgical and Dexcom, have posted multi-bagger returns during our holding periods to date. We still have high expectations for others, such as Moderna and BioNTech. Meanwhile, we continue to research compelling names not currently held in the portfolio, such as Guardant Health and Wuxi Biologics. Where strong company fundamentals align with the deep secular shift to cheaper and personalised healthcare, opportunities for extreme returns will follow.

Past performance is not a guide to future results. Changes in the investment strategies, contributions or withdrawals may materially alter the performance and results of the portfolio. All investment strategies have the potential for profit and loss.

Past performance is not a guide to future returns.

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The views expressed should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.

This communication was produced and approved in January 2024 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.

Potential for profit and loss

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