Helicos BioSciences (HLCS) is an attractive speculation, with a 3 year target of $20
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The VCA theme DNA Sequencing has attracted 20 venture capital investments since January of 2006. There have been three deals in the last month. The VC community has identified DNA sequencing as one of the hottest healthcare growth areas in the world.
The rationale behind VC interest is straightforwared. Decoding the genome allows scientists to develop more effective, more individualized medicine. Applications for genomic medicine are being developed right now in categories such as Disease Testing, and eventually scientists will use the information available in an individual’s genome to create custom-built antibodies to target specific diseases for specific people.
To get to this personalized medicine nirvana, however, the process of sequencing an individual’s genome must be made cheaper and faster. The Human Genome Project published the first complete human genome in 2003 after approximately 13 years and $3 billion in funding. Progress since 2003 has been incredibly rapid. In mid-2005, the estimated cost of mapping a genome had dropped to $24 million. You can have your own genome mapped right now, in April of 2008, for $350,000.
The tipping point for DNA sequencing is widely considered to be decoding a human genome for less than $1,000 and in less than 1 hour. At that point, decoding an individual’s genome would arguably be part of a complete physical exam. The $1,000 genome sequencing process is a reasonable 5 year target for several of the technologies being brought to market now.
Given the 5-7 years it takes drugs to get through the FDA after they have been discovered, the global healthcare industry knows that they need to begin work on applications for genomic science within their various fields immediately. The demand for next generation sequencing (”NGS”) machines was very strong during 2007, and I am confident that demand will continue to grow over the next three and five years.
Competition is fierce
The DNA sequencing business is in rapid flux right now. The three top competitors in the NGS market are Applera Corporation’s Applied BioSystems Group (ABI), Illumina Inc. (ILMN), and Roche Diagnostics’ 454 Life Sciences division.
Applied Biosystems posted $557 million in DNA sequencing revenues in 2007, while Illumina did $327 million. Illumina’s 2007 revenues were up 97% over 2006, driven by their market leading Solexa product. Illumina is projected to grow 42% during 2008, to $519 million in revenues.
Applied Biosystems’ revenues were flat in 2007 compared to 2006, a poor showing compard to Illumina’s growth. Applied Biosystems recently came out with a new NGS product, called the SOLiD. As a result, I would expect Applied Biosystems to bounce back this year, delivering over $600 million in revenues in 2008.
The Internet has hosted an active debate over which company has the best technology. The conclusion seems to be that the new SOLiD machine has brought Applied Biosystems’ technology back into par with Illumina’s Solexa product line. Applied Biosystems’ DNA sequencing revenues during 2008 should maintain a thin lead over Illumina, while Roche trails both leaders.
Helicos BioSciences (HLCS) is jumping into the fray with an offering that is faster than these larger competitors. The company claims that their new machine, having shipped to their first customer in February, has the ability to decode a human genome for an industry low $72,000. Importantly, Helicos uses a new technology called “true Single Molecule Sequencing” (tSMS) that they claim gives them a path to the key target of $1,000 per genome decoding.
- “We can look somebody in the eye and say, ‘This instrument is going to get you to the $1,000 genome,’ said Steve Lombardi, the president of Helicos.”
There are other competitors coming down the pike, including Pacific BioSciences, Intelligent Bio-Systems, NABsys, VisiGen Biotechnologies, and Complete Genomics. All of these new competitors are developing DNA sequencing machines that they believe will drive the price of sequencing a human DNA genome below $10,000; some are shooting for sequencing a human genome in under an hour for a cost of hundreds of dollars.
The activity among startups is not surprising. After all, this activity is what drew our attention to the space.
Here is the Bull case for Helicos
View the spreadsheet used for this valuation analysis.
With all of this competition, why buy Helicos? Well, there is clearly a multi-billion market opportunity up for grabs over the next 3-5 years. If Helicos is able to capture even a small portion of the market — say, $100 million in revenues by 2010 — the stock will be a huge winner.
By the end of this year, Illumina will have essentially built $500 million in revenues over 3 years from a standing start. I believe this DNA Sequencing category will actually grow faster over the next three years than it has over the last three years. Helicos clearly has a chance to build a big business over the next few years.
You can click the spreadsheet link above to see the details, but basically I have developed a December, 2010 target price for Helicos of $20 per share. The stock is trading at $7 right now, which would imply a 47% annualized internal rate of return over the next three years. A 25% annualized internal rate of return would be sufficient for me; accordingly, I would buy HLCS up to $11 per share. The spreadsheet above includes a table showing annualized internal rate of returns delivered at various price points given the $20 target price.
I’ve made several assumptions in developing this three year target value of $20.
- I am projecting $100 million in revenues for Helicos in 2010.
- Similar to Illumina during 2006 and 2007, I am projecting 25% operating margins for Helicos in 2010.
- I think Helicos needs to raise $75 million in additional cash. Accordingly, I am assuming 50% share dilution, based on two secondaries of Helicos stock (3 mm shares at $10 and 3 mm shares at $15). Including options dilution, this brings the Helicos shares outstanding from 21 million currently to 29 million in 2010.
- I place a 7 multiple on 2010 estimated sales and a 30 multiple on 2010 estimated earnings.
If Helicos makes it to profitability in 2010, their long term outlook remains exciting. If they follow in Illumina’s footsteps and develop a $500 million business, their stock could reach $70 — a 10 bagger off of the current $7 stock price.
The Bear case is also clear, unfortunately
$70 is the bull case for Helicos. The bear case is that their machines do not sell and their stock price moves lower. They make one last highly dilutive capital raise late in 2008 to stave off bankruptcy, then they go gently into that dark night. Helicos is burning $10 million in cash every quarter, and they have $40 million in net cash outstanding. If they do not produce operating momentum — in the form of machine sales — as 2008 progresses, the bear case becomes more and more likely.
Helicos could be acquired
There is the potential for Helicos to be acquired. Without a substantial revenue base, however, I doubt that an acquisition would happen at more than $200 million ($10 per share). The potential for an acquisition is not a good reason to buy Helicos’ stock.
The recent CFO exit
To execute on their business plan, Helicos will need to raise cash by the end of 2008. That wasn’t the plan when the company went public last year. The initial public offering was supposed to raise $70-$80 million rather than the $48 million it brought in. Helicos was forced to lower their offering price from $15 to $9 to get the offering done. As a result, they did not raise the capital they needed to make it through 2008.
I note with some amusement that their lead banker in the offering was UBS — the only broker with a Sell recommendation on Helicos’ stock last year. Your lead banker is not supposed to be the low man on the street.
I would think that this combination of a poorly run IPO and the evident need to raise additional financing over the next 12 months had something to do with Helicos’ CFO “resigning” in March. The resignation coincided with the stock dropping from $10 to $7.
61% of Helicos’ outstanding shares are owned by insiders, including founders and venture capital investors. That is not a forgiving crowd, and the CFO leaving may well have been a rational, performance based firing rather than evidence of operational weakness.
This is speculation on my part, but I choose to see the current $7 stock price as a buying opportunity. I would buy Helicos up to $11 per share as an attractive bet in a high growth area.
1 Response to “DNA Sequencing and Helicos BioSciences (HLCS)”Leave a Reply |
Your bear case seems to have played out. We are now at mid August 2008 and they’ve not sold more than 1 machine. And even that machine they did not charge for. They’ve lost a huge amount of ground to all three major players: Roche, ABI, and Illumina. Meanwhile they’ve taken $20M in loans from GE. Difficult to see them raising much more cash.