Murphy Antes Up to GeneChips

10/23/2002 12:00 am EST

Focus:

Michael Murphy

Former Editor, New World Investor

"It’s been over two years since scientists published the first draft of the human genome sequence," Michael Murphy, editor of Health Investing. "While important, this sequencing is only the first step in understanding and interpreting that code. Scientists now face the challenge of deciphering that data and understanding the genetic causes of diseases, which will one day lead to better treatments and possibly to outright cures." Here's his top pick for playing this growing trend.

"One way that researchers approach the challenge of understanding the genetic cause of disease is studying differences between genetic sequences and how those genes behave in healthy and diseased tissues. In the past, researchers could only look at isolated fragments of DNA. This is like looking at a painting through a small hole. But to fully appreciate the painting, we need to find a way to see it in its entirety.

"Enter DNA microarrays, which consist of thousands of DNA fragments crammed onto a small glass or plastic chip. Instead of looking at one gene at a time, microarrays follow the activity of an entire genome at a given moment. Microarrays offer the distinct capability of doing large-scale, industrialized biological research by studying extremely large numbers of genes and their activity simultaneously.

Affymetrix (AFFX NASDAQ) is the premier producer and leading provider of these microarrays. The company has made significant strides in becoming the ‘gold standard’ in whole genome analysis. Indeed, the firm's microarrays are becoming a standard in the academic and drug development communities. The firm has an impressive list of customers, including Glaxo, Pfizer, Millennium, Biogen, Monsanto, and Johnson & Johnson. Plus, over 250 scientific publications have specifically cited the use of these chips this year.

"The company's core product is the GeneChip microarray. They have sold a lot of these chips. According to management, the firm sold 280,000 chips in 2001. The market’s steady demand for these products is evident in the firm’s growing revenues. In the second quarter, Affymetrix placed 690 GeneChip systems (the computerized reader) and shipped 97,000 chips, booking $70.7 million in sales. Total revenues should reach $285 million this year, up over 26% from 2001. Revenue growth should continue at a 37% rate for the next five years as new customers adopt the system, more systems are placed with existing customers, and chip usage per system increases. 

"One way I value companies that are not yet profitable is to look at how much they have spent on research and development in the last five years.  By the end of this year, Affymetrix will have spent $274 million on gene chips.  That's a huge barrier to anyone else entering this market.  With a total market capitalization of $1.2 billion, AFFX sells for only 4.4 times what they have invested in their science, which is cheap for a company that's developed successful products.  All in all, Affymetrix is an underpriced, unique drug development tools company. I want you to buy AFFX under $23 and set a tight stop loss at $19. My target for 2003 is $42, a nice double from here.”

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