Description

No Offer or Solicitation; Not Investment Advice. The information in this presentation is not an offer to sell or the solicitation of any offer to buy any securities, or an offer to provide investment advice or a solicitation of such an offer. This information is not investment advice, and no one should rely on the information contained in this presentation to make any investment decision.

This is a synopsis on a timely spin-off that we thought would be useful to get out to the group. Grail (NASDAQ: GRAL) is focused on early cancer detection through blood-based screening tests. Recently spun off from Illumina (NASDAQ: ILMN), a leader in DNA sequencing technology. 

The key value offering is a simple blood test with a low false-positive rate that can quickly diagnose a variety of cancers. On a risk-adjusted basis, we think a small position is compelling to put early on due to the dynamics of the spin-off, while larger funds perform additional VAR.

Background 

85.5% of Grail was spun off from Illumina on June 24th 2024 to shareholders; the culmination of an activist battle with Icahn over the acquisition, eventually leading to the former CEO Francis DeSouza's resignation. The new CEO Thaysen joined as Illumina’s CEO on Sept. 25 after working at Agilent (NYSE:A).

Grail was spun with $1B in cash, due to EU regulators requiring 2.5 years of funding if put into a separate business. Evercore saw this figure around $2 billion, and may require capital raises throughout 2025 / 2026. Illumina financed this at  a 6.7% rate on their credit facility. 

Ilumina acquired Grail in August 2021 after splitting off in 2016 after early incubation. It was acquired for roughly $8B USD in cash and stock. The company was fined $430M EUR for not undergoing european regulatory review before closing the transaction.

Illumina had 159.3M shares as of Q1 2024, and had a 1:6 ratio, implying 31.2M total shares of Grail (after factoring in the remainder Illumina still holds) or a ~460M market cap as of 7/12/2024.

More About Grail

Grail's Galleri test has key read-outs for its registrational studies slated in NHS-Galleri and PATHFINDER 2, which will culminate in FDA submission and broad reimbursement. 

NHS-Galleri is fully enrolled with over 140K study participants, with final data expected in 2026 focused on performance. PATHFINDER 2 is mostly regarding safety, with the study almost fully enrolled.

Despite a lack of reimbursement and FDA approval, the company has sold over 180K tests to date and has >100 commercial partnerships ($93M in FY 23 revenue). This implies a ~4x multiple on revenue today, ignoring the cash balance. 

However, revenue growth has slowed from 68% Y/Y in FY23 to 36% Y/Y from Q1 2023 to Q1 2024. Guidance remains at 30-50% growth throughout 2024. Gross Profit was around $40M in 2023.

Some of the more interesting commercial partnerships due to the nature of the product are those with employers with low turnover, where the costs can be rationalized as part of a larger long-term employee benefits package. 

Why wasn't this sold instead of spun-off?

Any potential buyer of Grail would have required approval from the European Commission and likely other regulators. Given the high required upfront investment, this would likely have been a well-capitalized pharmaceutical company which would have had significant scrutiny. As mentioned above, $2B was estimated by Evercore for a 2.5 year runway without slowing investment, implying roughly $800M of net losses annualized.

Why wasn't investment in Grail slowed or shut down internally?

In our opinion, Illumina took a clear position by spinning Grail off to shareholders, rather than halting further R&D, that the spin-co would trade materially above >$1B. Adjusted EBITDA in 2022 and 2023 alone were -$1B combined. Additionally, the interest on the debt used in this transaction will cost Illumina around $67M annualized in the near-term.

Key Risks

Grail is shredding cash on its trials, with ~$250M slated in loss just for 2H 2024 ($500M annualized). An ATM or other means of financing may need to be explored going into 2026, as cash will run out right around or after the PMA filing. 

Gross profit from current sales are not sufficient to meet this timeframe without a change in valuation due to larger trial results. This may result in substantial dilution, but could also be seen as an incentive for the company to seek strategic alternatives with a larger sponsor, which may have less regulatory scrutiny.

Summary:

Trading to cash value today at spin would lead to a double to ~$30 per share. Longer-term, Galleri could easily generate over $5B to $10B in revenue at a 30% operating margin after broad insurance reimbursement.

Capital Markets Day Presentation: https://investors.grail.com/static-files/084931e1-fc15-4d44-a2b9-9aac1887c2f6

Catalyst

* Acquisition by a larger healthcare company around 2026

* Multiple expansion towards U.S. PMA Application of Galleri