Pacific Biosciences: A Small Cap Gem in the Genomics Market

By David Liang Markets Fool.com

Image source: Pixabay

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Shareholders of Pacific Biosciences of California (NASDAQ: PACB) have had a very volatile couple of weeks. Share dropped a whopping 44% in a single day in mid-December, though they've since recovered roughly 22%.

PACB data by YCharts

Are shares only rallying off the great news from PacBio competitor and genomics giant Illumina (NASDAQ: ILMN) at the J.P. Morgan Healthcare Conference? Or is the recent rise a signal that PacBio is turning a corner? It's time for a closer look.

How gene sequencing works

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Pacific Biosciences of California develops and manufactures genome sequencing machines which utilize their proprietary Single Molecule, Real Time (SMRT) sequencing technology. The majority of commercially available DNA sequencing machines rely on a process known as "short-read sequencing" in order to sequence genomes. This process consists of creating tens of thousands of strands of identical DNA molecules through a process known as "PCR amplification." These thousands of DNA strands are then anchored to a base and "flushed and marked" with nucleotide reagents in order to identify specific DNA bases. In plain English, DNA sequencing machines work by taking the DNA molecule, multiplying it, washing those DNA strands in a marking reagent, and then identifying those markings and their associated DNA bases using the machine.

The advantages of this process are high throughput and low cost per identified base -- one of the reasons Illumina will potentially be able to sequence a whole human genome for as low as $100in the near future. While short-read sequencing is cheap and is the industry standard, it does have a few disadvantages including limited read length, amplification bias, slight variation in accuracy, and a long time to result.

Differentiation

Unlike the majority of commercially available DNA sequencing machines, PacBio's SMRT technology allows for the observation of DNA synthesis in real time through the use of phospholinked nucleotides. Phospholinked nucleotides are nucleotides which have had a fluorescent dye attached to the nucleotide chain. When the nucleotide is incorporated into the DNA strand, the phosphate chain is cleaved and the dye molecule is released. Though this process, PacBio's SMRT technology machines are able to synthesize and sequence genomes in real time. The advantages of this process include longer read lengths, lack of amplification bias, and higher accuracy. PacBio's current SMRT technology machine lineup includes the PacBio RS System (released in 2011), the PacBio RS II (released in 2013), and the Sequel System (released in 2015).

Since inception, cost has always been the main issue plaguing PacBio. The RS II System sold for $750,000 -- a similar price to the much higher volume HiSeq series from Illumina. However, PacBio has dramatically improved on this front with the Sequel System, which will sell for half the cost of the RS II and yet produce 7x the throughput. While PacBio's Sequel's $3,000 per human genome cost can't compete with Illumina's HiSeq X's $1,000 genome, the Sequel has been called "the gold standard of high-quality, whole human genomes," and "the best sequencer money can buy."

The future of PacBio

The cause of PacBio shares' aforementioned December nosedive was news that Roche had decided to terminate their agreement to develop, commercialize and license products from Pacific Biosciences based on PacBio's SMRT technology. While this news was unfortunate for Pacific Biosciences, the company had already earned the final developmental milestone payment from Roche and is now free to commercialize products based on their Sequel platform or work with other distribution partners.

As a value investor at heart, I can't end my discussion on PacBio without discussing its current valuation. Currently hovering at around a $450 million market cap, PacBio is 50x smaller than its competitor Illumina. However, it is important to note that PacBio will never be an Illumina. Instead, PacBio sells its products to laboratories that prioritize longer reads over short reads, accuracy over throughput. Since its launch in late 2015, PacBio has sold and installed a total of 75 Sequel systems. In Q3 2016, PacBio shipped 20 units and expects to increase this number in Q4. Assuming Q4 does 25 units, this puts us at an annual 2016 rate of 100 Sequel units. At $375,000 a unit, 100 units, and a $500 million market cap, PacBio is currently trading at over 13 times extrapolated annual sales. For comparison, Illumina is currently trading at only 9 times sales.

PacBio offers a differentiated product, and shares are down over 50% since the beginning of 2016. However,dueto its lofty valuation and Illumina's dominant position within the genomics industry, I would hold off on buying PacBio for now.

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David Liang has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Illumina. The Motley Fool recommends Pacific Biosciences of California. The Motley Fool has a disclosure policy.