DEVON Equity Management, an investment management firm, published its “Global Opportunities Fund” second quarter 2021 investor letter – a copy of which can be downloaded here. A portfolio return of 14.1% was recorded by the fund for the second half of 2021, while its benchmark by comparison returned 12.3% for the same period. You can view the fund’s top 5 holdings to have an idea about their top bets for 2021.
In the Q2 2021 investor letter of DEVON Equity Management, the fund mentioned Illumina, Inc. (NASDAQ: ILMN), and discussed its stance on the firm. Illumina, Inc. is a San Diego, California-based biotechnology company, that currently has a $73.04 billion market capitalization. ILMN delivered a 35.22% return since the beginning of the year, while its 12-month returns are up by 24.85%. The stock closed at $498.42 per share on August 03, 2021.
Here is what DEVON Equity Management has to say about Illumina, Inc. in its Q2 2021 investor letter:
“At the ASCO Meeting in early June, GRAIL released interim results from the PATHFINDER Study. Recall Illumina (5.6% of NAV) are in the process of acquiring GRAIL for US$8bn (discussed in our Q4 2020 Investment Letter). The PATHFINDER Study assesses the performance of Galleri, an early detection test for up to 50 different types of cancer. The Study delivered 45% positive predictive value (PPV), meaning if a positive test result were returned there was a 45% likelihood the patient had cancer.
Whilst 45% might seem a relatively ‘low’ level of accuracy, the results were received positively, since absent the Galleri test many of these cancers are likely to have gone undetected (given a lack of alternative testing or diagnostics).
The Galleri Test is now available on prescription in the US, and GRAIL have commenced a real-world Study in a much larger US patient population (in addition to a sizable trial with the NHS in the UK). In the race to develop broad based early stage cancer detection tests, from an operational perspective GRAIL is clearly exhibiting impressive progress. Frustratingly, Illumina’s acquisition of the company has been complicated by regulatory intervention in both the US and EU.
In a surprise move, the US Fair Trade Commission (FTC) moved to block the merger on competition grounds. Illumina will vigorously contest the FTC’s move in the courts. Illumina / GRAIL represents a ‘vertical’ acquisition, where the FTC has historically taken keener interest in ‘horizontal’ acquisitions (such as Illumina’s unsuccessful attempt to acquire Pacific Biosciences in 2019). The last major vertical acquisition contested by the FTC was AT&T / Time Warner in 2019. In this case the FTC was unsuccessful, as they failed to offer factual arguments as to how the merger would decrease competition in the Pay TV market. The merger duly closed. This brings us to the heart of why the FTC challenge came as a surprise in the Illumina / GRAIL case.
Blocking a deal on competition grounds when the acquiree company (GRAIL) does not have any revenue, and the market which they are targeting barely exists seems a surreal concept. Effectively, the FTC will need to prove Illumina’s acquisition of GRAIL will be anti-competitive in a market which doesn’t really exist. The FTC’s concern centres on the dependency of other liquid biopsy players on Illumina’s sequencing machines to read samples. Illumina’s binding commitments to lower sequencing costs to all liquid biopsy players by at least 45% over the coming years would appear to weaken the FTC argument that this acquisition could lead to price increases for non-GRAIL liquid biopsy players.
The EU’s intervention came as even greater surprise, as GRAIL neither generates revenue nor has any physical operations within the European Union. Even for the incumbent EU Competition Commissioner (whose track record illustrates a desire to intervene in anything and everything), this looks like severe regulatory over-reach.
Considering the merits of the FTC / EU’s case, we think Illumina is likely to prevail. Having said this, we fully appreciate regulatory outcomes can be unpredictable (and influenced by political / ideological agendas at the respective regulatory agencies). In the event the deal is blocked we remain comfortable with Illumina’s prospects on a standalone basis.”
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Based on our calculations, Illumina, Inc. (NASDAQ: ILMN) was not able to clinch a spot in our list of the 30 Most Popular Stocks Among Hedge Funds. ILMN was in 52 hedge fund portfolios at the end of the first quarter of 2021, compared to 45 funds in the fourth quarter of 2020. Illumina, Inc. (NASDAQ: ILMN) delivered a 32.30% return in the past 3 months.
Hedge funds’ reputation as shrewd investors has been tarnished in the last decade as their hedged returns couldn’t keep up with the unhedged returns of the market indices. Our research has shown that hedge funds’ small-cap stock picks managed to beat the market by double digits annually between 1999 and 2016, but the margin of outperformance has been declining in recent years. Nevertheless, we were still able to identify in advance a select group of hedge fund holdings that outperformed the S&P 500 ETFs by 115 percentage points since March 2017 (see the details here). We were also able to identify in advance a select group of hedge fund holdings that underperformed the market by 10 percentage points annually between 2006 and 2017. Interestingly the margin of underperformance of these stocks has been increasing in recent years. Investors who are long the market and short these stocks would have returned more than 27% annually between 2015 and 2017. We have been tracking and sharing the list of these stocks since February 2017 in our quarterly newsletter.
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Disclosure: None. This article is originally published at Insider Monkey.
