Illumina, Inc. (ILMN 3.32%) recently reported the fastest sales growth for its genetic sequencing machines in three years, and while that's great news, even better news may be its announcement it's buying a major competitor, Pacific Biosciences (PACB 6.91%). The surprising move expands Illumina beyond its already-dominant position in short-read DNA sequencing to long-read sequencing, and that could pay off big-time for investors. 

What's going on 

When the human genome was first sequenced in the 1990s, it cost $3 billion. Since then, advances in technology have driven the cost of sequencing DNA below $1,000, and expectations are that, eventually, it will cost as little as $100 to sequence DNA.

A man in a shirt and tie looking through binoculars.

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That's pretty remarkable, because it opens the door wide for researchers to think about gene sequencing in entirely new ways that can improve patient health. For instance, it can be used in sequencing large patient populations to spot DNA similarities that may be contributing to disease and, and making sure next-generation therapies designed to edit genes to correct mutations work as promised.

Already, big strides are being made toward this next era of personalized medicine. Biotech and pharmaceutical companies are plowing money into research and development projects that use sequencing to determine which genes they can switch off and on to more effectively battle back against autoimmune diseases, rare diseases, and cancer.

The leader gets even bigger

Illumina has been at the forefront of gene sequencing since the beginning, and as a result, it's established itself as the biggest manufacturer of gene sequencing machines and consumables used in gene sequencing on the planet.

In fact, nobody's even close to it in terms of its size and reach. Illumina employs more than 6,200 people, it operates offices in 22 countries, and the installed base of its machines exceeds 11,000. Its machines have been used to perform 90% of all sequencing done to date. 

The company's dominance stems from its expertise in short-read DNA technology that allows for faster and less expensive sequencing. But future sequencing applications may increase the need for long-read expertise, and that's why Illumina's $1.2 billion acquisition of PacBio is so important.

A much smaller company, PacBio has carved out a niche in the long-read space; however, a lot of its sales have been in China, and trade tensions have posed challenges for the company that may have contributed to management's deciding now is the right time to sell.

The acquisition nets Illumina PacBio's latest, recently launched long-read technology, which "doubled the previous output of the current PacBio Sequel system." Also, it allows the company to get in front of next year's expected launch of PacBio's 8M Zero Mode Waveguide (ZMW), a chip that increases outputs and reduces long-read sequencing costs significantly. Once that chip is available, the cost of long-read sequencing could fall from about $7,000 today toward $1,000, unlocking opportunities for more widespread use.

In short, this deal provides Illumina with a soup-to-nuts short-read and long-read product lineup. Given its size, Illumina should be able to leverage its much larger sales force and manufacturing footprint to drive interest in PacBio's Sequel products, increase sales, and make this acquisition profit-friendly.

Integration will be key

Illumina is on track to deliver $3.18 billion in revenue this year, up from $2.75 billion in 2017, and $4.75 to $4.85 in adjusted earnings per share. That's a sharp contrast to PacBio, which had $18.2 million in revenue and $25 million in losses last quarter alone. Therefore, PacBio's ongoing losses present a headwind to Illumina's post-combination earnings.

The company expects there to be some synergies, but it's staying mum for now on exactly how dilutive, or not, this combination will be to it in 2019. For now, Illumina's focusing investors on the potential opportunity associated with having a comprehensive product suite that can help those with short-read needs and long-read needs, particularly as interest in genetically engineered medicine rises. 

Illumina estimates that the total addressable market for long-read applications was $660 million last year, and that it could grow at a 30% compound annual rate to $2.5 billion in 2022. I think Illumina's size will allow it to capture most of that opportunity, and if so, then a $1.2 billion purchase price will pay off big for investors over the next few years, making this one of the most significant deals ever in the gene sequencing industry.