Image Credit: Monty Python and the Holy Grail

Genomic sequencing pioneer Illumina (Nasdaq: ILMN) has spent the better part of the past decade on a never-ending quest. And one of the most dramatic storylines of the health care industry began entirely by accident.

Illumina had been selling its high-throughput sequencers and consumables for more than 15 years. Its machines could read and organize a patient’s DNA, to detect very specific and known conditions.

But it made an unexpected discovery in 2015.

It was running one of its routine Non-Invasive Prenatal Tests (NIPT). This was a blood test done on expectant mothers, to screen their unborn babies for certain monogenic conditions like Down’s Syndrome while they were still in the womb.

Yet Illumina realized that its NIPT test was detecting something else as well. It noticed there were DNA fragments from a cancerous tumor circulating within the mother’s bloodstream. Accidentally, Illumina had diagnosed that the pregnant mother was showing signs of an early-stage cancer.

This was a revolutionary discovery for the genomics industry. Illumina’s new CEO Francis deSouza, who had just taken the helm the following year, immediately spun-out an independent division of Illumina and named it GRAIL. It would focus exclusively on perfecting a “multi-cancer early detection” (MCED) test that could detect and diagnose cancer in its earliest stages.

This was outside of Illumina’s core business of selling sequencing machines and consumables. But it was too intriguing to ignore.

The following year, Illumina partnered up with Bill Gates, Jeff Bezos, and the capital arm of Google to provide $100 million of initial funding for GRAIL. This was nothing more than a science project at the time, but it began to develop its Galleri diagnostic that would have very high accuracy and sensitivity.

Galleri would still use Illumina’s machinery to do the sequencing. Detecting early-stage cancers was extremely difficult and quite expensive. But Illumina already had innovation in its DNA. After all, the company made a name for itself two decades earlier as the sequencing company who powered the Human Genome Project.

Over the next four years, GRAIL went on to raise $2 billion in capital from even larger partners including Johnson & Johnson, Bristol-Myers Squibb, Celgene, and Merck — as well as from well-known venture capitalists like Sequoia and prominent pension funds. It felt like everyone wanted a piece of this revolutionary new quest to cure cancer.

Then something else unexpected happened.

In late 2020, deSouza announced that they would be re-acquiring GRAIL and bringing it back under the Illumina umbrella. The Board had approved a cash-and-stock deal worth a whopping $8 billion, as Illumina was eager to unleash Galleri on a $75 billion oncology diagnostic market.

But hold on just a second there.

GRAIL hadn’t actually produced a single dollar yet in revenue. It didn’t even have a commercialized product. And now Illumina — who was a publicly-traded company with a fiduciary responsibility to its investors — was wanting to acquire it back again for 80-times the price of what it spun it off for just five years ago?

The Strategy Had Issues

Even if things didn’t financially make much sense, Illumina seemed confident it was on to something. But there were more elephants that quickly joined the room.

One of the largest issues was a strategic one. Illumina was selling its machines or partnering with other oncology diagnostic companies such as Invitae, Natera, and Thermo Fisher. But if Illumina were to commercialize its own cancer diagnostic, would that put it in direct competition with its partners?

The company had the expectation that acquiring GRAIL would result in synergies. GRAIL specified a supply and commercialization agreement with Illumina, where Illumina would be the sole and preferential supplier of its NovaSeq sequencers and would open up its sequencing data libraries. In exchange, GRAIL agreed to pay Illumina a “mid single digit” royalty of any of Galleri’s sales.

But how could Illumina recognize those synergies, without them creating an unfair advantage and coming at the expense of its other customers?

That question remained unanswered. Many believed Illumina would be turning its own customers into its competitors.

But regardless, Illumina plowed forward anyway with its proposed acquisition.

The Execution Had Issues

Illumina’s customers weren’t the only ones who didn’t like this acquisition. Regulators in the United States and Europe weren’t fans of it either.

The Federal Trade Commission and the European Commission were raising red flags as well about the combined company having antitrust concerns. Illumina’s dominant presence in the sequencing market could suppress free-market competition in the diagnostic market through its preferential treatment of GRAIL.

Rather than working with the regulators to address their concerns, Illumina took to the offensive.

The company pledged to “vigorously defend” its acquisition of Grail. It even filed its own lawsuit against European regulators, just to keep them from investigating the deal any further. And in response to the FTC, Illumina claimed “there was no legal impediment to acquiring Grail in the U.S.”

That’s where things started to get ugly.

The EC issued Illumina a massive fine of 432 million euros ($476 million USD) in 2023. It was the largest merger-related regulatory fine it had even issued, for closing the acquisition before it had formally given its blessing. Both the EC and the FTC ordered Illumina to divest GRAIL as soon as possible.

Where We Stand Today

And this captivating history is what leads us to where we are today.

Illumina is finally co-operating with its investors, its customers, and its regulators by agreeing to spin-off GRAIL as a separate company once more.

Illumina investors will now get one share of Grail — as an independent company — for each six Illumina shares they currently own. Illumina will retain a 14.5% minority ownership stake in Grail, which is an equivalent percentage to what it owned before attempting the acquisition.

The investing world will now watch to see what value GRAIL can independently command, as “GRAL” will begin trading on the Nasdaq on June 24th.

Grail’s financials are still a mess. It reported only $93 million in revenue last year, but recognized a gross loss of ($96 million) and an operating loss of ($1.6 billion).

Yet many believe the intrigue of its revolutionary new cancer diagnostic could still command a multi-billion dollar valuation. While Illumina’s quest to obtain the Holy GRAIL has officially ends here, the next chapter of its story could turn out to be even more exciting.

Based on this updated investment analysis, 7investing is updating our conviction and risk rating for Illumina.

To see our team’s latest ratings for Illumina plus full due diligence on more than 200 other investment opportunities, sign-up at 7investing.com/subscribe with coupon code “Illumina” to get a free first week and also a 15% discount on our annual membership.

Already a 7investing member? Log in here.