Global Equity: Changing the face of healthcare

What is Genomic Sequencing?

Genomic sequencing is a technology with the potential to change healthcare as we know it today. DNA is the code of life, by understanding this code, new solutions to dramatically improve the wellbeing of humanity can be achieved.

The pandemic has accelerated the adoption of this technology and offered glimpses of its incredible potential. Moderna’s SARS-Cov-2 vaccine was developed using only the genetic sequence of the virus, this was the stuff of science fiction only a few years ago.

What is the impact of Genomic Sequencing?

Uses for Genome sequencing will not be limited to just jabs. Genomic sequencing will have a profound impact on humanity, so much so that by the year 2025, according to a study by McKinsey, Next-Generation Sequencing, “will add between $700 billion to $1.2 trillion annually” predominantly by saving human lives i.e., saved premature deaths due to better treatment outcomes.

What are the applications?

Non-invasive prenatal testing (NIPT), rare and undiagnosed diseases, population genomics, oncology and consumer are emerging growth markets which many scientists are excited about.

Today, oncology drug treatments remain challenging. Yet, thanks to genome sequencing, treatment effectiveness can be significantly improved. Cancer is ultimately a disease of the genome and is caused by errors in the DNA which drive tumour growth. By comparing a cancer cell to a patient’s healthy cells, it is possible to identify how the cell has mutated. Knowing what caused each patient’s tumour enables personalised treatments which leads to better results.

The study of how genomes affect a person’s response to drugs is called Pharmacogenomics. By combining pharmacology and genomics it is possible to effectively develop safe medications that will be tailored made to a person’s genetic makeup. The dawn of personalised medicine is upon us.

Separately, the lower cost of the technology today has led to a surge in growth for consumer genomics. By knowing what genetic diseases you are prone to, it is possible to adjust your lifestyle and monitor accordingly. Thanks to genome analysis it is also possible to discover ancestral origins; several online sites offer such services.

The use of genome sequencing extends beyond human DNA. The advancements and efficiencies in genome sequencing capabilities are increasing the ability to understand and engineer biology. A recent study by McKinsey highlights 400 applications, almost all of which are scientifically feasible today. Besides human health, agriculture, aquaculture, food, consumer products & services, materials, chemicals all feature. Cumulatively these applications, over half of which fall outside of human health, could have a direct economic impact of up to $4 trillion annually over the next 10 to 20 years. The full potential could be much larger if potential knock-on effects, new applications yet to emerge and additional scientific breakthroughs materialise. The Biological Revolution, which has been in the decades in the making, is truly underway.

Technological Advancements

Now while genetic information is a very powerful tool, historically high costs have limited its availability and, by extension, the impact it can have. Yet progress is being made, at break-neck pace. Harvard University professor George Church, who is widely recognised as a leading pioneer within the field summed it up by stating:

“Genomic sequencing is 10 million times cheaper and 100,000 times higher quality than what is was just a few years ago”

Over the past two decades, technological advancements within the sequencing industry have been predominantly led by Illumina. This company has been at the forefront of lowering the cost of genomic sequencing so much so that the cost declines in genomic sequencing are referred to as Flatley’s Law, after the legendary CEO Jay Flatley who led Illumina from 1999-2016.

Illumina has stated that it has the infrastructure in hand to bring down the genomic sequencing costs from $600 today to $100 in the near future.

Illumina – the market leader

Illumina’s success in driving down costs and superior technology has led the company to deeply entrenched itself within the industry. According to Illumina’s management its gene sequencing instruments and consumables are used in over 80% of all sequencing applications today.

Illumina employs a lucrative razor and blade model – the firm sells sequencing and scanning instruments which require consumables such as reagents, flow cells and microarrays. This model is often attributed to Gillette: “Give them the razor; sell them the blades”.

Prior to the pandemic, Illumina achieved 20 years of uninterrupted revenue growth. This has led its share price to compound by over 24% annualised over the past 15 years, yet it is still early days.

Runaway growth ahead

According to a 2019 presentation DeSouza, Illumina’s CEO explained that less than 0.02% of human genomes have been sequenced and less than 0.01% of species have had their genomes sequenced. He further elaborated "the ubiquity and impact of genomics will dwarf everything we've seen to date”.

Illumina’s Competitive Advantages

Numerous deep pocketed players have tried, but so far it has been impossible for anyone to dethrone Illumina’s market leadership position. The company enjoys several key competitive advantages.

The number of sequencing systems has proven to be stable over time. Industry know how, experience and field understanding are essential. R&D and legal costs related with patents of proprietary technologies are massive. Therefore, the fixed costs are high and tend to represent 45% to 60% of total industry costs. Therefore, economies of scale, such as those provided by Illumina’s approximate 80% market share, is crucial.

In the genome sequencing market, consumers tend to have low price sensitivities because they do not have many equivalent options. Competition in this industry is predominantly related with technological developments. From this perspective, Illumina’s blend of run costs, turnaround time, read lengths, throughput and error rates beats the current competition.

At a first glance, Illumina tends to have the highest prices compared to rival equivalent platforms yet both it’s cost per GB of data and the observed error rate are best in class.

In order to remain at the forefront, Illumina invests approximately 18% of its revenue in R&D, which is double the industry standard. Currently, the firm has more than 1400 issued/pending patents. Patents enjoy 20-year terms therefore prevent competitors from directly copying its technology for a long period of time. Additionally, even similar tools have been difficult for other firms to engineer given the high complexity in the field.

Illumina has a best in class, proven workforce with unrivalled expertise in biochemistry, electronic instrumentation and complex data analysis, the three critical and highly technical fields in genome sequencing. Product commercialisation has proved extremely difficult for many competitors despite funding from venture capitalists. In additional Illumina has a venture capital arm Illumina Ventures, which can scope up any interesting new technologies.

The company also has a very large installed base of 15,000 systems. Illumina requires customers to buy their instrument platforms in order to process their arrays, as other firms’ chips cannot be processed on their systems. Therefore, this should translate into ongoing sales of high margin consumables (73% of 2019 revenue)

The company’s large installed base also creates switching costs for customers looking to jump ship. Having incurred large upfront costs to acquire the equipment, it will be hard to justify switching to a new provider and retrain staff barring the absence of a revolutionary technology. Furthermore, depending on the end use, many of Illumina’s clients are tied by long term (15 year) contracts.

Illumina’s Risks

Despite Illumina’s dominance, we closely monitor disruptive entrants in this rapidly evolving industry. We acknowledge that the exponential development within the industry clouds visibility and perceive this to be Illumina’s greatest risk.

Illumina closely monitors a number of competitors including the likes of Oxford Nanopore, Thermo Fisher Scientific and the Beijing Genomics Institute (BGI).

In the short term, BGI is increasingly shaping up to be Illumina’s most formidable competitor. The technology is similar to Illumina’s, but it is currently being held out of the U.S. and other developed markets due to patent rights as Illumina had sued BGI, successfully proving that patents had been infringed. Even when those in-question patents expire (in the next few years), Illumina claims that its newer instruments are protected by new patents.

Whilst switching cost mitigates this risk, it is also hard to know if and when the company will introduce newer and cheaper technologies. For commercial reasons, companies are not very open about the product pipeline.

Furthermore, as highlighted by Illumina’s $1.2 billion failed takeover attempt of Pacific Biosciences (due to antitrust regulation) in 2018, even after effectively identify acquisition targets, due to Illumina’s dominance, acquisitions are getting practically impossible.

Illumina attempted to acquire Pacific Biosciences due to its promise in long-read sequencing. Illumina’s own long-read sequencing device the TruSeq Synthetic long-read DNA library prep kit has been discontinued leaving Illumina to be focused on short-reads.

Long-read technologies are great for de novo sequencing projects (where you don’t have a map of the target genome already – think about new species academic research or sequencing a new virus/variant in the field, etc.). Currently Illumina’s short-read focus is not a major issue. It is projected that the long-read technology could probably address ~10% of the total genomic sequencing opportunity while short-read technology is appropriate for the rest. Yet the long-read and short-read technologies could collide in terms of competing. Rapid technological advancements are taking place which are mitigating a number of key deficiencies of long-reads. The long-read sequencing is growing twice as much as the short-read sequencing. In the medium to long term, Long-read Sequencing such as those offered from Pacific Biosciences and Oxford Nanopore could became more of a threat.

Illumina faces heightened execution risk. One serious misstep or failure to acquire a realisable disruptive technology can seriously inhibit Illumina’s long-term success. Whilst short-read sequencing is expected to continue to dominate the sequencing market, particularly as liquid biopsy becomes part of the annual health check-up, the lack of long-read capabilities is a concern.

Illumina mitigates this risk by investing heavily in its R&D. The company has recently disclosed a few key new product developments.  For example, its Chemistry X initiative could serve as the platform that crushes sequencing costs to the so far elusive $100 per genome milestone. It is also faster, more accurate, and longer-read technology, and with such capabilities should stave off competition. Illumina's Dragen technology also could make analysis of the data derived from genomic sequencing much quicker (40 times faster genome alignment and variant calling) and more accurate (2 times). Additionally, the company also plans to re-enter the long-read market by introducing a long-read technology on its existing platforms called Infinity that could help Illumina compete better with the likes of Pacific Biosciences and Oxford Nanopore Technologies in long-read applications.

Other risks include funding constraints. The firm’s customers include universities and research labs which could face funding cuts whilst its clinical customer base can face reimbursement hurdles.

Illumina’s $8 billion Grail acquisition

We have received a number of questions around Illumina’s $8 billion Grail acquisition.

Illumina has been in the limelight for completing the acquisition despite ongoing reviews of the transaction by the European Commission and the US Federal Trade Commission.

The decision to acquire Grail prior to getting clearance was described as a “maverick move” by a leading Evancore analyst and disappointing by EU regulators.

IIlumina’s CEO DeSouza defended this decision. Leveraging on Illumina’s resources, Grail could distribute the test more broadly, scale up Grail far more quickly and work on reimbursement. Illumina estimated that just by accelerating reimbursements by one year, 10,000 American lives could be saved. Ultimately, Illumina felt that the stakes were too high and management felt they had a moral obligation to save lives.

We believe that this has been a calculated risk from Illumina. Whilst many analysts point out that deifying the EU regulators has exposed the company to fines (Illumina highlighted than fines could be up to 10% of annual revenue), many seemed to miss that if the deal was not consummated by December 20, 2021, Illumina would need to pay a $300 million termination fee. Furthermore, Illumina had to take the drastic action as due to delays from the European regulators, Illumina would not have been able to meet the deadline for the acquisition to go through. By proceeding with the deal, the company was simply letting the outcome to be decided by the courts other than by technicality (time lapsed issues).

Management also highlighted that Grail will operate independently and be kept completely separated until the courts decide on the outcome.

We believe that Illumina was caught on the backfoot and did not anticipate the pushback seen from the regulators. This has been the first time that the European Commission is reviewing a deal that does not trigger either EU or National-notification thresholds.

Similarly, the Federal trade commission took the highly unusual step of challenging a vertical merger. There has only been one such litigation merger in more than 40 years. The Justice Department’s 2017 case against AT&T’s acquisition of Time Warner in which the government lost.

lllumina is actually disputing that the EU has jurisdiction to block the deal on the basis that Grail does not operate in the European Union and is not expected to for a number of years.

The FTC are concerned that the acquisition will curb innovation and lead to higher prices. Yet Illumina invests 18% of revenue on R&D, twice the industry average. On its website, the company also offers Grail’s competitor’s long-term contracts with price declines spread out over 12 years and has informally proposed concessions such as "contractual guarantees of equal and fair access to its sequencing and a commitment to drive down prices by more than 40% by 2025.

Furthermore, as we shall will be discussing below, there is no directly competing product currently on the market or in development.

Overall, we think that Illumina will likely prevail.

How Grail came about

Illumina’s subsidiary Verinata Health was undergoing tests for its non-invasive prenatal testing (NIPT) product. These tests where run over 100,000 times and achieved excellent results other than a handful of cases where an unknown foreign signal was detected. This information puzzled the Illumina’s research team, particularly when all the babies were born normally. It was only when Rick Klausner, the former director of the National cancer institute, who had just joined Illumina at that time, looked into the data and speculated that the foreign object was indeed cancer. Unfortunately for the mothers, he was right. The prenatal test had detected tumour fragments in the bloodstream.

Illumina’s research team had inadvertently discovered that it is possible to detect cancer from a simple blood test. Illumina’s CEO DeSouza explained that the research team had goosebumps when discovery was made. They know they were potentially on to something massive. Cancer claims over 9 million lives a year, a simple blood test which could potentially detect cancer early could avoid so many premature deaths.

Illumina felt that it had a moral obligation to put this test out on the market as quickly as possible yet they did not have the financial resources to do so.

Therefore, in order to expediate this process as much as possible, Illumina set up Grail and spun it off. Funding was obtained from a number of leading investors such as the Bill and Melinda Gates foundation, Bezos expeditions, Johnson & Johnson, Sequoia capital and Illumina itself.

Today Grail uses what is known as ultra-deep level genome sequencing in order to test for circulating nucleic acids which are fragmentary DNA and RNA that are shed by cancer from the earliest stage into the blood.

Why is Illumina so keen on acquiring Grail?

Simply put, we believe that Liquid Biopsies could prevent more cancer deaths than any medical intervention in history.

Early detection saves lives

Early cancer deduction may induce a paradigm shift in when a cancer is detected and then treated.

By detecting cancer early, with testing, it is projected that 100,000 cancer-related deaths can be averted each year in the United States. This is because cancer is far more treatable when it is detected early.

Treating Early-Stage Cancer is not only more effective, it is substantially cheaper too

Currently over $200 billion is spent on cancer care in the United States. Frost & Sullivan research showed that treating localised breast, stomach, liver, and colorectal cancer in the United States costs 2.3 times less per patient. These differentials imply cost savings of $92,000 per patient on average in early stages when compared to treatments in late stages of those same cancers.

1.8 million people are diagnosed with cancer annually in the United States. Morningstar estimates that in an aggressive scenario of detecting 80% of cancer cases in the initial stages would result in cost savings of $70 billion annually.

Yet cost savings go far beyond the cost differentials cited above. The value of human life can never be quantified. The better quality of life due to better treatment outcomes liquid biopsies can bring is intangible.

Economies and societies stand to benefit substantially. In the US alone, the present value of future earnings after cancer mortality is estimated to be over $145 billion according to a recent study titled "Productivity Costs of Cancer Mortality in the United States”.

The nascent liquid biopsy market is projected to expand exponentially over the coming decade. Morningstar estimates that the liquid biopsy market could eventually exceed $70 billion in the United States alone, with global demand doubling the total addressable market in the long run.

The largest opportunity is in pan-cancer indication – this when a single test is used to screen for multiple types of cancers. Pan-cancer indication is expected to reach $30 billion in the US alone.

Cumulatively the opportunities for individual tests are expected to be even larger and make up an additional $40 billion. Colorectal cancer indications is expected to became a >$18billion market opportunity whilst Breast cancer indications is another significant market at just under $18 billion.

The opportunities for the Rest of the world (outside US) is expected to be equivalent to the US market over the long term.

Grail - First mover advantage

Screening for 50 different cancer types, Grail’s Gallieri is the first Pan-Cancer indication biopsy test launched. It also has the ability to detect far more different types of cancer than any other test currently in development.

It is indicated that Exact Sciences could possibly launch a competing product screening for approximately 14 different types of cancer in 2026. Burning Rock and AnchorDX are expected to be in a position to launch their products in a similar time frame to Exact Sciences.

Other companies which are involved in testing include Invitae and Helio health however the potential launch date is yet unknown.

Grail have got the first mover advantage and opportunity to become the long-term market leader in this very large nascent market.

Malcolm Schembri
Fund Manager - EPIC Global Equity Fund