Outside of some notable struggles among small and unproven companies, this has been a surprisingly strong year for life sciences companies. This strength, and relatively health multiples, is coming despite relatively unimpressive revenue growth and signs that 2013 could be a very tough year for the academic and government lab sectors. Consequently, while Life Technologies (Nasdaq:LIFE) is certainly worth a spot on a watch list, it's hard to muster a lot of enthusiasm for the stock right now.
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Tough Results Against Weak Expectations
If there's a good side to the numbers that Life Tech reported for the third quarter, it's that investors were expecting a pretty uninspiring result to begin with. In line with what we've seen from other healthcare/life sciences companies such as Danaher (NYSE:DHR), General Electric (NYSE:GE) and Abbott Labs (NYSE:ABT), this was a tough quarter all around. Revenue fell 2% as reported, though Life Tech saw revenue growth a bit above 1% on a currency-adjusted basis. None of the reporting units were up on a reported basis, with flat revenue in Applied Science coming in best. Research Consumables sales fell 3% (rising 1% constant currency), while Genetic Analysis saw negative 1% reported sales growth (and 2% growth cc) as strong Ion Torrent sales offset weakness in the older SOLiD platform.
Margins, too, were unimpressive. Adjusted gross margin dropped a half-point (though a gross margin above 65% is still pretty good relative to most companies). Operating income went up slightly, but operating margins weakened by more than a point as the company continues to invest in marketing (particularly in markets such as China).
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ASHG Probably a Non-Event, but Life Tech Continues to Build
While the American Society of Human Genetics (ASHG, or "A-Shag") remains a highly significant annual meeting in the life sciences space, companies such as Illumina (Nasdaq:ILMN) and Life Tech seem to have de-prioritized it as a platform for major new announcements, preferring instead to make those announcements at times and places of their choosing and control. Consequently, while a lot of investor attention may focus on San Francisco next week, I don't expect a lot of major news from the big players (though it's still a big meeting for companies such as Fluidigm (Nasdaq:FLDM)).
That's not to say, however, that Life Tech hasn't been busy. The company continues to see a lot of growth from its Ion Torrent acquisition, and new launches such as Ion OneTouch2 and Ion Chef should keep the company well-positioned as a threat to Illumina. On the diagnostics side, the company has been making a lot of announcements lately (including a collaboration with Bristol-Myers Squibb (NYSE:BMY)), but the company is still a ways away from being a real player in that market.
Speaking of which, I expect diagnostics to continue to dominate a lot of the discussion around these life sciences companies. Whether it's Life Tech, Nanosphere (Nasdaq:NSPH), Luminex (Nasdaq:LMNX), Agilent (NYSE:A), Qiagen (Nasdaq:QGEN) or Illumina, this is where all of the companies feel they need to be. Now while Agilent made a big step in buying Dako and Qiagen has been pretty active and aggressive lately in signing Big Pharma partnerships, there's a big difference between making a deal (or an announcement) and making a business. To that end, I still have my doubts about whether Illumina can really establish a presence here.
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What's 2013 Going to Look Like?
The funding environment out there is still pretty rough, and companies such as Illumina, Life Tech and Affymetrix (Nasdaq:AFFX) have outsized exposures to academic and government labs. If the United States goes off the fiscal cliff and triggers sequestration, upwards of 8% of the budget for institutions such as the NIH could be at risk - a spending cutback that will filter down throughout the academic sector. Now, Life Tech has among the highest blend/mix of consumables of life tech companies (Sigma-Aldrich (Nasdaq:SIAL), Thermo Fisher (NYSE:TMO) and Techne (Nasdaq:TECH) are pretty high up there as well), and that will help some. What's more, the overlap between the federal budget and the timing of grant awards and payouts aren't perfect. Nevertheless, I'd be careful when aggressively buying life tech stocks with big government spending exposure (most academic research is actually underwritten by the government) unless you have a particular bullish thesis that argues that these areas will be spared significant additional cutbacks.
The Bottom Line
I do like the balanced business at Life Tech, and I believe this company has a good chance of succeeding in building out a worthwhile diagnostics business. That said, there already seems to be ample optimism in these shares. I think Life Tech will be challenged to grow free cash flow (FCF) much above a mid single-digit rate, as I think legacy businesses and competition will weigh on growth. With that sort of growth rate, fair value would fall in the high $50s, making Life Tech a good hold but maybe not a great buy candidate. For those investors wiling to project that ongoing success in genetic sequencing and diagnostics can push the free cash flow growth rate into the high single digits, a fair value in the mid-$60s could make this a more interesting stock today.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.