AFFX: Two Votes for GeneChips

01/17/2003 12:00 am EST

Focus:

Michael Murphy

Former Editor, New World Investor

Since the days of the Gold Rush, when fortunes were made by selling picks and shovels to miners, providers to an industry have often been better positioned than industry players themselves. Indeed, one way to avoid the risks inherent in the biotech industry is to focus on those who provide the instruments required for research. Here, Michael Murphy and John McCamant recommend a biotech "tool" maker.

"Affymetrix (AFFX NASDAQ) is unique among our recommended companies in that it does not make drugs and so does not rely on clinical trials," notes John McCamant, editor of The Medical Technology Stock Letter.  "AFFX manufactures the leading microarrays on the market. These products, called GeneChips, are used as research tools by academic research labs and biotech and pharmaceutical companies. AFFX will announce their 2003 milestones on January 29 in their quarterly conference call. We expect they will predict 2003 revenue of a little over $300 million, a greater than 20% increase over 2002 revenues. The increase in revenue will come in part from increased use of GeneChips by existing customers, but, most importantly, from their expanding base of customers. For example, they placed 50 new GeneChip Systems (the instrument used to process and analyze the arrays) in the third quarter of 2002. Each of these $100,000 systems consumes, on average, seven times its purchase price per year of GeneChips and continues to drive future growth.

"Although university laboratories were AFFX's first customers and still provide a strong base, we expect the highest percentage increase in sales to be in the biotech and pharmaceutical sectors. Potential milestones for this year could be progress on small diagnostic chips that could be used to type cancers. (Arrays can distinguish tumors with accuracy not previously possible.) Small specialized arrays could also be used to screen patients for clinical trials and track their response to treatment on a molecular level. This type of product would move GeneChips from the research arm of R&D into the development side, where 80% of drug development dollars are spent. Other areas for growth include Europe and Japan, where AFFX will begin direct sales later this month.

"Finally, Affymetrix announced the impending launch of its next-generation microarray scanner, the GeneChip Scanner 3000. This machine is roughly the size of a desktop computer and provides improved speed, image quality, and accuracy over previous models. Consider this bottom line: AFFX turned profitable and sustained double-digit sales growth in a year in which biotech was unable to raise money and academic research instrument purchasing was weak overall. We think they've shown their mettle and expect sales will be surprisingly good as the economy improves. AFFX is a buy under $30."

Adds Michael Murphy, editor of Health Investing," Affymetrix announced that Perlegen, its private-spin-out focused on capturing gene expression information, has formed an alliance with Bristol-Myers Squibb. Perlegen will identify markets that predict patient response to various BMY drugs. Bristol-Myers is giving Perlegen undisclosed research funding, milestone payments, and royalties. Perlegen also gets certain rights to diagnostic tools and other intellectual property resulting from the research. 

"Affymetrix also entered a strategic alliance with Arcturus, a private micro-genomics company, which sells equipment and reagents that isolate cells with lasers to extract nucleic acids and proteins. This is a necessary step in gene expression analysis, so there is a natural synergy here. AFFX will give Arcturus broad access to GeneChips and related instruments and software, with the goal of creating new array and diagnostic products. 

"In our opinion, Affymetrix is one of those companies using our improving knowledge of genetics to improve healthcare right now. One of the best ways to rapidly and accurately identify specific genetic signatures is with an Affymetrix GeneChip. The company has sold hundreds of thousands of these chips for research purposes this year and will sell more next year. Buy AFFX under $23, with a stop loss of $19."

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