Genetics split investor sentiment

US gene analysis firm Illumina (NASDAQ:ILMN) was a newcomer to last week’s list of companies hitting a 52 week high regarding short selling. This has illuminated us to an arena where investors are expressing strong, yet divided views. With life expectancy having doubled in the last 55 years and cancer continuing to elude modern medicine, it is not surprising that there is plenty of interest in the area of science that can “map” the genetic effects of these conditions. We will look at: Illumina (NASDAQ:ILMN), Pacific Biosciences (NASDAQ:PACB), Life Technologies (NASDAQ:LIFE), Sequenom (NASDAQ:SQNM), and Human Genome Sciences (NASDAQ:HGSI).

In the same way that phone makers have to choose an operating system around which to build their phones, the genome research centers (e.g Universities) need a third party platform to enable efficient genome sequencing. Still with me? The parallels with the smart phone OS war continue since there is only a choice of three, with Illumina (ILMN) leading the way at present. Its success has persuaded institutional investors (whose behavior we can proxy by looking at the holdings of funds who lend) to lift their ownership from 27% of the company to 32% in the last 6 months. By way of example, the equivalent figure for Pfizer is only 23%.

So why are 21% of the company’s shares being borrowed? Illumina has convertible bonds in issue (as do many in this sector) which could explain a certain proportion of the borrowing. However, it doesn’t explain a succession of spikes in demand since November, taking the short interest from 18m shares to a 2 year high of 30m on the 22^nd February. Interestingly, this is far higher than the short selling figure of 10m shares being publicly reported.

With a P/E ratio of 78 it could be a case of the value investors shorting the company against growth investors, who are happy to ignore a high valuation. However, we have noticed a spike in the demand to borrow the other two genome platform providers, so the negative sentiment looks like an industry view rather than company specific worries about Illumina.

Life Technologies (LIFE) makes another popular product for genetic scientists, and though small in overall terms at 0.6% of total shares outstanding on loan, shows a recent spike in demand. Conversely, the institutional investors own close to a 2 year high at 29% of the firm. Pacific Biosciences of California (PACB) is focused on a slightly different type of genome reader and short interest is at a new high of 4.5% of total shares outstanding on loan following the company’s November IPO. This represents a high proportion of supply, since institutional ownership, though rising, is quite low at 4% implying some shorts are being covered from non-institutional supply.

Elsewhere in related companies, both Sequenom (SQNM) and Human Genome Sciences (HGSI) witness diverging investor opinion with rising short interest alongside rising ownership from funds who lend. Sequenom shows a large recent spike in stock on loan to 15% of the company as the shares falter while Human Genome Sciences is short sold to the tune of 10% total shares out on loan, which is a 6 month high. Looking over the last half year, funds who lend do not share this pessimism and appear to own record amounts of these firms.

Companies whose customers (like Universities) rely on government grants and charitable fundraising to pay for services could face headwinds and this could be the reason for the short selling. Those with a longer term horizon are instead buying more of these firms given the crucial role they will play in better understanding human disease. Both could be right.