What happened

Shares of Illumina (NASDAQ:ILMN) rose 13% last month, according to data provided by S&P Global Market Intelligence. That added about $4 billion in market cap following an impressive first-quarter 2018 earnings announcement at the end of April and the release of an updated investor presentation on May 3.

Last month, the gene-sequencing specialist also announced the acquisition of software developer Edico Genome (May 14) and held its annual shareholder meeting (May 23). While no single news event spurred the stock's move upward, investors received a number of data points that collectively suggest the company is successfully expanding the base of installed instruments and building recurring revenue streams from consumables. 

A pair of hands holding stacks of coins, with a green line drawn over them showing growth.

Image source: Getty Images.

So what

Snatching up Edico Genome will provide Illumina with new data analytics tools for its high-growth next-generation sequencing (NGS) offerings. The new software tools promise to deliver results faster and in smaller data files, which is no minor consideration when working with the massive amount of information contained in large sets of genes or even an entire genome.

Acquisition aside, investors still appear to be misreading the opportunities and challenges facing Illumina. Years ago, management struggled to explain that selling instruments, while a key part of the overall business, is a secondary consideration when compared to consumable sales, which are responsible for 64% of total revenue.

Today, investors are still obsessed with hardware sales. Worse, they're obsessing over the newest and highest-end instrument (the $985,000 NovaSeq), when a bigger opportunity might actually reside in selling lower-priced instruments to more customers for different applications. At $20,000, the current iSeq may still be too expensive to fully exploit that opportunity, but it sports a price point that could really open the door to much bigger customer bases. 

The market also appears to be overlooking the rise of competitor Oxford Nanopore, which is taking a novel approach to DNA sequencing that could pose a serious risk to Illumina's business. While Illumina CFO Sam Samad recently dismissed the tiny competitor's technology as needing a 200% to 300% improvement in accuracy to catch his company, that's actually a pretty low hurdle in the fast-moving space.

In fact, Oxford Nanopore recently announced a path forward for greatly improving the accuracy, cost, and time to results of its systems. If those efforts succeed, then investors may be forced to reconsider Illumina's $40 billion market cap before too long.

Now what

Illumina has a solidly profitable business that churns out gobs of cash flow. It's growing the lineup of instruments available for purchase (although I think investors are focusing on the wrong end of the lineup), building a DNA consumables empire, and tapping into long-term opportunities in consumer markets. That should make investors confident in the business's near-term trajectory.

There's more uncertainty in the long term, however, especially with an expensive market cap of $40 billion and healthy competition brewing. If Oxford Nanopore continues to succeed with its technology platform, then Illumina may not have quite as firm of a hold on the DNA sequencing markets of the future as investors seem to think right now.