Biotechnology, more than the Internet, seems ever more likely to be the Rule Breaking industry of the 21st century. While the "dot-com" craze has largely come and gone, the biotech revolution may be longer lasting.
Because it takes so long to develop and test drugs, it's only natural that the biotech revolution is still in the Rule Breaking phase of its life cycle. It may be there for a long time. While the list of profitable biotechs is steadily growing, the vast majority are unprofitable, and most don't even have products on the market. All of this explains why our portfolio doesn't have a pure biotech company, and why the biotech pool is prime hunting ground for our friends in the Rule Breaker Portfolio.
What's the point? My hypothesis about Rule Breaking industries, one that's relevant to Rule Maker investors, is that companies that emerge from Rule Breaker industries with Rule Maker credentials the earliest, are more likely to be the monster Rule Makers as the sector matures.
If a Rule Maker investor wants to reach for higher return potential with a portion of the risk, my gut tells me to look at Rule Breaker industries. Companies we think of as obvious Rule Makers like Microsoft (Nasdaq: MSFT) and Intel (Nasdaq: INTC) were among the first to emerge with "Maker characteristics" after the tectonic shift from mainframes to PCs.
Microsoft first hit our $1 billion annual sales target back in 1990. Intel generated $3.9 billion in sales that same year. Amgen (Nasdaq: AMGN) was the first mover and top dog in the biotech sector and hit the magic mark of $1 billion in 1995, after getting very close in 1991.
While Amgen is still a holding of the Rule Breaker Portfolio, there's no question it qualifies as a first-tier Rule Maker. My nomination for the most likely next big biotech Rule Maker is Applied Biosystems, a business unit of PE Corp.-PE Biosystems Group (NYSE: PEB). It's a leader in selling the "picks and shovels" genomics and proteomics companies will need to mine for gold in the human genome race. Applied Biosystems is best known for its affiliation with sister company Celera Genomics (NYSE: CRA).
The Gillette of the biotech hardware business
The truth is that Celera and Human Genome Project wouldn't have celebrated the successful sequencing of the human genome without the ABI Prism 3700 DNA Analyzer, which represented a quantum leap in sequencing capacity. While the human genome race may be over, the market for sequencing equipment is probably in its infancy. With Celera and other companies racing to sequence the genomes of all manner of species, and to determine individual gene expression, the market for DNA sequencers isn't likely to slow anytime soon.
Applied Biosystems dominates the market for DNA sequencers, with about an 85% market share. It has an installed base of approximately 1,100 of the high-end 3700 model, costing about $130K each. (It also has a large installed base of middle- and low-end sequencers.) In addition, each machines produces about $100,000 per year in recurring sales of consumables, giving AB a true "razor and blade" business model. While profit on the machines is decent, the true economic beauty comes from selling the reagents needed to keep the machine sequencing.
Moreover, the company isn't standing pat with the 3700. It's attempting to broaden the market of potential customers by introducing a new mid-priced sequencer, the Prism 3100, that will offer many of the advantages of the high-speed 3700 for lower-volume customers such as university labs. The price will be about half that of the 3700, and the new 3100 model is expected to reduce person time from about 5 hours per 24 hours of operation on the current mid-priced model to about a half hour per 24 hours.
These advantages are expected to induce switching from the company's older, mid-priced model and to induce sales to new customers. Finally, AB is expected to launch a new top-end model sometime in 2001 that could offer as much as a sixfold increase in throughput speed. You can bet that Celera will be buying these machines as soon as it can, which means any company that wants to compete with Celera better buy them too.
More and more gear
The sequencers are just one small part of Applied Biosystems' business. The company is also a leader in providing infrastructure products to the biotech and pharmaceutical industries: instrument systems, reagents, software, as well as consulting and contract research services. With companies like Celera shifting their emphasis from creating data to actually using the data to discover therapeutic compounds, it appears Applied Biosystems will once again be a major catalyst in the search to locate and identify proteins, which many analysts describe as being the Holy Grail of drug discovery.
To keep on the cutting edge of this new focus on proteins (called proteomics) -- made possible in part by the data coming from the human genome -- AB is currently developing new mass spectrometry systems for use in protein identification that could increase protein analysis throughput 10-fold within one year, and as much as 100-fold in two to three years.
Like most of our Rule Makers and emerging Rule Makers, PE Biosystems Group shares are priced at a hefty premium to the market. With a market cap around $19 billion, the company is priced at just over 100 times trailing 12-month sales, with an expected growth rate around 20%. To find out more about Applied Biosystems, I recommend checking out the FAQs discussion board written by community member and Soapbox author ElricSeven. I've also posted the Rule Maker stats for Applied Biosystems on the Rule Maker Companies board.
