Affymetrix: Three stumbles then a step?

Affymetrix: Three stumbles then a step?







AFFX 41.42







Affymetrix has had another tough quarter. Affymetrix has now given Wall Street three lower forecasts in a row. This time they claim two factors: One, instrument sales for about $10 million is below expectations. For the full year instrument sales are down about 20%







Two, they were product constrained in the array market and that also reduced their revenue growth by about $5 million. The company added about 30% more capacity in 2005 and expects to add another approximately 30% more capacity in the next quarter.







Affymetrix believes they have grown the DNA analyzing business by about 100% annually for the last three years and this business is about an $80 million business.







Affymetrix claims they have about 50% more in orders than the previous years to a record backlog level. They believe the constraint should ease later in 2006.







In the expression line they will be launching many new products.



The expression grew at 7% in 2005







Affymetrix has a business model that is becoming more like a razor and blade business. When you buy the instruments it's like buying a razor then you need to buy the arrays and reagents what Affymetrix calls consumables those are like the razor blades.







The consumables are growing at a 20-30 organic growth rate over time. Affymetrix believes it would be closer to 30% if it were not capacity restrained.







I talked to several people in the field and no one has identified a competitor that has been taking away market share even though Affymetrix was not executing at a rate that Wall Street was expecting.







Affymetrix still believes that they will grow costs at about half the rate that they grow revenues, and they expect to grow revenues at least 15% in 2006. With that in mind profits should still grow at the 30% range for 2006.







They were expecting a large contract to come through the fourth quarter that will be pushed into the next quarters.







Conclusion







It appears Affymetrix was misguided on what their customer need. They are providing genotyping services and DNA services that are competing against some of their clients and as they grow this service business at a close 100%, that growth could continue to cannibalize some of their instrument sales to companies they now compete against.







It's my opinion you buy outstanding companies when the stock is down or out of favor. That often happens around a product transition period. It appears that Affymetrix is missing the quarterly revenue guidance mostly to the transitional issues and not that much to the more serious problems of new competitive products taking away market share. To me, Affymetrix has a very strong business model in an outstanding industry. The values appears high compared to many technologies companies I follow especially after it's third earning shortfall in a row, but compared to many in the DNA market it has a value lower then most.







Affymetrix is rare because it has one of the best business models in the DNA market we could identify. In knowing it has all the ingredients needed to continue being a company with some of the highest degree of control in their market that we have measured.











Disclosure:



Randy Durig manages the Monopoly Technology and Monopoly Blue Chip Portfolio's He tries to own companies that measurably have control or monopolize their markets.





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