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How Sequestration May Impact Life Science Sector

 December 28, 2012 02:18 PM

(By Mani) For the Life Science Tools space, the key focus for investors has been the potential impact of sequestration on revenues in 2013 and beyond. While companies remain optimistic that the government will develop a sequestration workaround, the January deadline is nearing.

Investors face the reality that to avoid the eventuality of the sequester they must rely on a lame-duck congressional session. The current fiscal 2013 continuing resolution (CR) does not address sequestration. However, closer examination of the National Institutes of Health's (NIH's) operational plan under the CR may be a good proxy for how the agency will address sequestration.

"Importantly, our re-analysis of the NIH's current operational policy has led us to believe we were vastly underestimating how dire the consequences of sequestration will be for the industry," Oppenheimer analyst David Ferreiro said in a client note.

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As has been the NIH policy under prior CRs, non-competing renewal funding has been cut by 10%. Over the past five years, non-competing renewals account for about 75 percent of NIH extramural grant funding. Extramural budget is over two-thirds of the total NIH budget.

"We estimate that this cut falls disproportionately on laboratory experimental (consumables) budgets, as both salary allocations and the proportion of indirect costs (varies by institution and often >50% of total award) remain static (or increase)," Ferreiro noted.

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As a result, under a CR, laboratory research budgets experience a much greater transient reduction in actual dollars available to spend on experiments (consumables).

NIH Director Francis Collins recently stated that sequestration would translate into about 2,300 fewer grants. However, this may underestimate the actual impact. The NIH will likely be forced to reduce the funding levels of non-competing renewals in addition to a reduction in new grant awards.

"In our view, this may be the only way to achieve the 8.2% reduction outlined in the OMB report outlining the President's sequestration plan," the analyst said.

Investors may wonder why an 8 percent cut could feel like more for the industry. Approximately 75 percent of all NIH extramural grants are non-competing renewals in a given year. Moreover, greater than 70 percent of the direct grant costs can be fixed (salaries).

In addition, a 10 percent cut to non-competing renewal funding could reduce the available dollars for research consumables by up to 25 percent.

"Therefore, any long-term reduction to the level of funding for non-competing grant renewals will come at the expense of actual lab budgets, likely magnifying the impact on life science tools providers," Ferreiro.

Among the life science stocks, Illumina Inc. (NASDAQ: ILMN), Fluidigm Corp. (NASDAQ: FLDM) and Life Technologies Corp. (NASDAQ: LIFE) are the most exposed to NIH funding.



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