Merger or Not, Pacific Biosciences Needs to Deliver

One year ago, Pacific Biosciences (PACB) laid out an ambitious technology roadmap. The main goal was to significantly lower sequencing costs and drive sales of its upcoming Sequel II system, which launched at the end of April. If the platform lives up to the original promise, then the cost of sequencing a full human genome could drop to $1,000.

The exact price isn't that important; it was mostly used as a proxy to communicate the magnitude of improvement from the legacy Sequel to the Sequel II. What is important is delivering vastly more affordable genomic data. If the system succeeds, the company's niche sequencing approach, called long-read sequencing, could become more mainstream and grow from a $660 million market opportunity in 2017 to $2.5 billion in 2022. 

The success or failure of the system in the marketplace could have existential consequences for Pacific Biosciences if its proposed merger with Illumina (ILMN 0.51%) is abandoned, and will determine how readily Illumina can position itself for the future of DNA sequencing if the deal proceeds.

Image source: Getty Images.

What makes the Sequel II so important?

Pacific Biosciences originally envisioned releasing technology upgrades that would make its Sequel II system and single-molecule real-time (SMRT) sequencing technology more economical, namely through a combination of better chemistry, software, and cells (the hardware that reads DNA). The goal was to reduce the cost of reading a human genome from $12,000 in early 2018, then to $7,000 in late 2018, and finally to $1,000 in early 2019.

Successfully reducing the cost of generating genomic data on the Sequel II will allow long-read sequencing to be used much more broadly in biological research and to compete with the rise of Oxford Nanopore and its nanopore sequencing approach (another type of long-read tech). Short-read sequencing -- the approach deployed by Illumina -- is useful for its low-cost and accuracy, but it cannot read up to 9% of the human genome, and isn't suited for certain non-human organisms. Ideally, researchers would be able to combine the two approaches to get a comprehensive view of a genome. It might even be possible to one day abandon short-read altogether.

Despite the importance of the Sequel II, investors are in possession of few details about its launch. Management hasn't held a quarterly conference call to discuss operating results since the proposed merger with Illumina was announced -- and it doesn't plan on holding any in the future, either, as it expects the merger to conclude in Q4 2019.

The only update is that Pacific Biosciences delivered 41 Sequel II systems through the end of Q2 2019 (including to five early access customers, some of which may have multiple systems). That's a pretty solid start, but investors should remember that customers had been reducing purchases of legacy products in anticipation for the new system since at least Q3 2018. Therefore, it's too soon to say if the strong start was due to pent-up demand, or if the momentum will prove sustainable for the long haul.

Data source: SEC filing. YoY = Year over Year.

Given the continued significant operating losses, it seems that Pacific Biosciences is still struggling to find commercial success. Therefore, if the merger with Illumina falls through, and the Sequel II doesn't gain sufficient market traction to enable profitable operations, Pacific Biosciences may not survive as a stand-alone company. 

That's especially true with the rise of nanopore sequencing. Clive Brown, CTO of Oxford Nanopore, quipped in late 2018 that the Sequel II would already be outdated by the time it launched. It already faces fierce competitive pressure from Oxford Nanopore's Promethion sequencing system, which offers much lower costs but struggles on accuracy (for now).

If the merger with Illumina proceeds, and the Sequel II doesn't gain sufficient market traction, then Illumina could struggle to maintain its absolute dominance of the global DNA sequencing industry. If Oxford Nanopore consumes the market opportunity in long-read sequencing by continuing to reduce nanopore sequencing costs while improving the accuracy of the approach, then it could also begin to lay claim to some of the market currently dedicated to short-read technology. There's a lot left to prove, but on paper at least nanopore sequencing has much greater potential to represent the future of DNA sequencing than short-read or the Sequel II.

A make-or-break technology platform

Investors must keep a close eye on the success of the Sequel II. There's no denying that it represents great technology that's valued by researchers, but it has to deliver profitable operations and prove competitive with nanopore sequencing. It's possible for that to happen even if Pacific Biosciences remains a stand-alone company -- and it would earn a $43 million payment from Illumina should the merger fall through -- but a history bereft of commercial success means investors need to remain grounded with their expectations if this stock will continue to be one to invest in.