In a somewhat surprising development, Illumina (NASDAQ:ILMN) recently announced its intention to acquire leading rival Pacific Biosciences (NASDAQ:PACB) for $1.2 billion. The move will combine the two leading DNA sequencing approaches, address a technology weakness in Illumina's current machines, allow Illumina to tap into smaller but faster-growing segments of the sequencing market, and allow researchers to rely on just one company for highly accurate genetic readings that can only come from combining both sequencing approaches.

Or that's what the press release said, anyway.

It's tempting to assume that the combination of Illumina and Pacific Biosciences leaves little room for outsiders in the industry's competitive landscape, especially considering the former boasts a market cap of nearly $45 billion. But the battle for the future of DNA sequencing is just getting started. A balanced discussion of the business and technical details shows there's much more uncertainty going forward than investors think.

A large fish about to eat a smaller fish but catching a hook instead.

Image source: Getty Images.

DNA sequencing is disrupting itself

DNA sequencing works like this: A researcher has a sample of DNA from a patient. The sample is tens of millions of base pairs long. The researcher needs to determine the most accurate sequence of the individual base pairs, and thinks the entire genome has medically relevant information. There are two approaches to choose from in 2018: short-read (Illumina) and long-read (Pacific Biosciences). Here's how they compare:

Metric

Short-Read

Long-Read

Starting DNA sequence

20,000,000 base pairs

20,000,000 base pairs

Chops that into...

"Short" fragments 150 base pairs in length

"Long" fragments up to 30,000 base pairs in length

Major advantages

Reads fragments many times to generate high single-base accuracy

Reads long stretches of genomes that short-read can't

Major drawbacks

Cannot read up to 9% of the human genome and requires a reference genome for accuracy

Low throughput of reads and is really expensive

Source: Author.

As the table above demonstrates, neither approach can unilaterally deliver the information needed. Short-read is blind to large swaths of the human genome (and many non-human genomes), and can only achieve its accuracy by comparing to a reference genome, which means the approach misses almost all clinically relevant genetic variation researchers now value the most. Meanwhile, long-read is just downright expensive -- nearly 12 times the cost of short-read.

That brings to light one crucial detail investors overlooked before the acquisition: The most accurate and complete DNA sequencing results come from combining both approaches -- not just relying on Illumina.

This practice is becoming more common as healthcare, agricultural, and industrial biotech knowledge expands. The expected market opportunity for long-read tech is expected to grow from $660 million in 2017 to $2.5 billion in 2022. When coupled with promises from Pacific Biosciences to drop sequencing costs from $12,000 to as low as $1,000 per human genome, the acquisition by Illumina makes a lot of sense.

But here's one crucial detail investors are overlooking after the acquisition: The same market forces dictating the combination of short-read and long-read approaches could eventually make both obsolete. The days of short-read appear numbered in any scenario, while nanopore sequencing may rewrite the definition of "long-read" on its way to the top.

Short pencils and long pencils.

Image source: Getty Images.

Long-read is the future, but "long-read" is relative

Evan Eichler, University of Washington Professor of Genomics and a living legend in the field of DNA sequencing, believes that when long-read sequencing costs drop to double the price of short-read sequencing costs, then short-read will be near its expiration date. In other words, long-read tech needs to reach around $2,000 to $4,000 per human genome if one factors in the real cost of reading a human genome. The premier machine from Pacific Biosciences was last attempting to reach the $7,000 mark by the end of 2018 before dropping to $1,000 in early 2019.

Investors might be right to question those bold targets by Pacific Biosciences, but Illumina apparently sees enough potential -- and perhaps the long-term risks to its short-read empire -- to gamble that it can drop the cost of the long-read sequencing approach in the next few years.

And time is of the essence. The future of long-read tech is up for grabs. Nanopore sequencing, the third DNA sequencing approach, is also considered a long-read tech, but it can achieve routine reads of 100,000 base pairs (the record is over 2 million base pairs). The next-generation approach is rapidly improving under companies such as Oxford Nanopore and Roche. Investors will remember that the latter dropped Pacific Biosciences as a partner years ago, with devastating results for the stock price -- and it did so to stake its future to nanopore.

A model of DNA for educational purposes.

Image source: Getty Images.

More telling, Oxford Nanopore has teased several impressive technical updates in 2018 that could address the approach's Achilles Heel of read accuracy and allow it to race ahead in the all-important sequencing metric of density (a measure that dictates sequencing costs).

If this is successfully commercialized, and the company can change the sour public perception about its data quality, then nanopore sequencing will become the top long-read technology. And it promises to do so in a much smaller footprint than any approach currently available, without the need for reference genomes, and all while allowing consumables (the chemical reagents needed to run DNA sequencing machines, and 79% of Illumina's total revenue in the first nine months of 2018) to be stored at room temperature rather than in expensive freezers.

Consider a comparison from the leading sequencing machines from each Illumina (NovaSeq), Pacific Biosciences (Sequel), and Oxford Nanopore (PromethION).

Consideration

NovaSeq (Short-Read)

Sequel (Long-Read)

PromethION (Nanopore)

Error rate

1 in 1,000

1 in 100,000

1 in 100,000 (in development)

Longest read length

150 base pairs

200,000 base pairs

2 million base pairs

Machine height

5 feet, 6 inches

5 feet, 5 inches

8.6 inches

Machine weight

1,059 pounds

780 pounds

88 pounds

Freezers required for reagent storage?

Yes

Yes

No

Source: Illumina, Pacific Biosciences, Oxford Nanopore.

Given all that, maybe Illumina isn't overlooking its top competitor after all. But that doesn't mean it will prove successful in its foray into long-read either.

Illumina made its long-read bet, but will it win?

Today Illumina's massive market advantage relies on a combination of low sequencing costs and unparalleled data reliability, which helps to provide a pricing edge when it comes to the real profit generator for the business: consumables.

But researchers have recently begun craving the depth of insights provided by long-read technology, and are likely to be inconvenienced by the current need to combine short-read and long-read approaches. That creates a huge opportunity for long-read, which has a higher ceiling than short-read in terms of technical potential, to grow into the de facto reading method -- if it can drop sequencing costs.

Illumina is aware of the shifting market dynamics and is moving to swipe the most proven long-read tech off the market. But investors may rightly wonder if the DNA sequencing leader bet on the right horse, especially with momentum building for Oxford Nanopore's nanopore sequencing approach. The answer may reveal itself in the next few years. In the meantime, buckle up.

Maxx Chatsko has no position in any of the 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.