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Illumina's Singapore Tax Holiday is About to Expire

The DNA sequencing giant generated over 10% of its diluted earnings per share in 2021 from a tax holiday in the island nation.

Globalization has both positive and negative impacts on American companies, and Illumina  (ILMN) - Get Free Report shareholders will become acutely aware of that when 2023 rolls around.

It's a rarely reported detail, but the DNA sequencing giant has enjoyed a generous tax holiday in Singapore in recent years. Illumina maintains robust manufacturing operations in the city-state.

According to SEC filings, the tax benefits were responsible for nearly 11% of the diluted earnings per share attributable to shareholders in 2021. They begin to expire in 2023. What happens after that? A combination of factors suggests it may not be pretty.

A Not So Jolly Holiday

Illumina shareholders are currently reeling from a spat between the company and European regulators. The European Commission, the bloc's trade authority, has fined the company 10% of revenues since completing the acquisition of liquid biopsy pioneer GRAIL in early 2021.

Regulators more recently completed an investigation that found the merger would harm competition in the fledgling blood diagnostics market, thereby blocking the acquisition and forcing its divestment. The DNA sequencing leader intends to appeal the decision, but investors must now confront a potentially messy unwinding of the liquid biopsy assets.

Investors will also need to brace for expiring tax benefits from manufacturing operations in Singapore.

According to SEC filings, the company has claimed over $145 million in Singapore tax holidays and incentives dating back to 2019. Illumina generated only 8% of total revenue in that span from the entire Asia Pacific region, which includes Australia, Japan, and other countries. Data for the first half of 2022 are unavailable.

In total, the generous tax situation in Singapore was responsible for 55 cents per share of the company's $5.05 per share of diluted earnings in 2021. It contributed 20 cents per share and 22 cents per share in 2020 and 2019, respectively. The earnings bump will decline as the tax holiday begins to expire in 2023.

Illumina has long used foreign tax jurisdictions to reduce its tax burden. For example, the business generated 52% of total revenue in the United States in 2019 but claimed 78% of its pretax income from foreign subsidiaries. That was the most recent year that excludes impacts from the pandemic and GRAIL acquisition.

The Hits Keep Coming for Illumina

If the European Commission emerges victorious (it has a pretty good track record in the last decade), then will shareholders see the business return to historical profit levels? It's tempting to think so.

Illumina delivered pre-pandemic and pre-GRAIL earnings per share of $6.74 in 2019, which was 33% higher than full-year 2021 EPS. A large part of the decline in recent years could be traced to the acquisition itself. The business saw pretax income in the United States fall $428 million from 2020 to 2021. Meanwhile, full-year 2022 guidance calls for negative EPS after accounting for costs from the GRAIL acquisition and regulatory fines.

On the one hand, divesting the liquid biopsy pioneer could allow the business to refocus on its core DNA sequencing business. That would simplify accounting and make Illumina a cash flow king once again -- albeit after incurring one-time costs from unwinding the assets.

On the other hand, investors might need to entertain the idea that the DNA sequencing titan is at or near its peak. Illumina has tried and failed to augment its existing technology platform in recent years, first through the abandoned acquisition of Pacific Biosciences  (PACB) - Get Free Report and now through potentially failed merger with GRAIL.

Both acquisitions were attempts to maintain its dominant market position. There's no denying Illumina remains the leading DNA sequencing company, but there's also no denying competition is the fiercest it's ever been. The pioneer faces threats from well-known platforms championed by PacBio and Oxford Nanopore, but also newcomers such as Element Biosciences and Ultima Genomics.

Many new technologies and platforms aim to drive down sequencing costs while offering scientists an off ramp from Illumina's de facto monopoly.

For example, the DNA sequencing titan unveiled the NovaSeq X machine at the end of September 2022 that promises to drop the cost to sequence a full human genome from $600 to $200. However, Ultima Genomics already sells a machine that delivers a $100 human genome. Other competitors are in the ballpark.

Additionally, many rivals are taking aim at the high capital costs incurred by using Illumina machines, which are often the size of refrigerators. The NovaSeq X costs $1.25 million. The PromethION instrument from Oxford Nanopore costs a fraction of that and can fit on a countertop in the lab. The ability of newcomers to make genomics research less expensive and more distributed is a significant advantage -- and a threat to the bulky, stationary status quo.

A bird's eye view of the tax, regulatory, and competitive landscapes paint an unfavorable picture of the future for Illumina. It's possible that the business is forced to offload GRAIL, loses its Singapore tax holiday, and begins feeling significant pressure from motivated rivals by this time next year. Investors may not be considering it yet, but the pioneer of DNA sequencing may have already reached its peak.