Companies that make the gene-sequencing devices used in scientific research face a tough few years as potential cuts to the U.S. federal budget squeeze funding to its main academic and research customers.

As the high cost of sequencing deters commercial use, the $1.5 billion market for gene-sequencers is dominated by genomic research centers, academic institutions and government laboratories that specialize in everything from finding causes for diseases to mapping the genetic make-up of crops.

These institutes largely depend on funding from the National Institutes of Health, which already had its budget cut by 1 percent this year, and faces another cut in 2012 just as it loses stimulus money that was authorised for two years.

My assumption is that the NIH budget could be cut by 1 percent in fiscal 2012, which means that if you incorporate the stimulus money rolling off as well, you could get a 2.5 percent headwind, said Leerink Swann analyst Dan Leonard.

Companies such as Illumina, Affymetrix and Life Technologies get 20-40 percent of their revenue from U.S. government-backed research and are expected to take the biggest hit from a funding cut.

Other more diversified players in the gene sequencer market -- expected to be worth $3.6 billion by 2015 -- with lower exposure to the funding risk include PerkinElmer, Waters, Thermo Fisher Scientific and Mettler-Toledo.

I have submitted proposals to the NIH that scored in the very top percentiles and would have normally been unquestionably funded, but were not funded as submitted because of cutbacks, Michael Schatz, assistant professor at Cold Spring Harbor Laboratory (CSHL), said.

Schatz, who is researching the genetic components of human diseases including autism and cancer, expects the downward trends to continue for several years, and said funding restrictions were limiting the number of new contracts awarded to gene sequencers.

MORE CUTS SEEN

Under last month's debt-ceiling law, a Congressional super committee was tasked with finding savings of $1.2 trillion to reduce the federal deficit. If it can't, certain discretionary items will automatically be cut.

In 2013, if the super committee can't come to any kind of agreement, then the NIH's budget could be cut by close to 8 percent, said Macquarie Research analyst Jonathan Groberg.

With unemployment rates soaring, Congress is likely to allocate funds to areas promoting job growth. Basic research may be crucial to innovation, but it doesn't directly create jobs.

If you're a congressman or senator going for re-election next year and you can't tie your advocacy for NIH funding to job creation, it won't be helpful, said Isaac Ro at Goldman Sachs.

The uncertainty could pressure the sector's stocks, which currently trade at almost a 20 percent premium to the broader Standard & Poor's 500 Index, Ro said.

In the credit crisis of 2009, these stocks traded at a 10 percent discount to the S&P. So the relative valuation to the market can still come down, he added.

The sector has historically traded around 30 percent ahead of the market because of its strong growth over the past decade and the promise of a big payout down the line.

There are also concerns about the impact on academic funding in Europe and Japan -- two major markets. Europe is battling with its own debt crisis and Japan is dogged by the continuing recession and the earthquake and tsunami in March.

A SILVER LINING?

While the funding crunch could hurt for a couple of years, the NIH's focus on developing genome sequencing to unlock its true potential could prove a lifesaver for the gene sequencers.

To achieve greater knowledge in the genetic variations contributing to common and complex disorders, it is necessary to sequence large volumes of genomes, the NIH said in its proposed 2012 budget request document.

The NIH said its goal is to halve the fully-loaded cost of sequencing a human genome to $25,000 this year, and cut it further to $15,000 by 2012.

This matches what manufacturers are trying to do: reduce prices to spur wider commercial adoption.

Biotechnology and pharmaceutical companies can utilize gene-sequencing on a larger scale to predict a patient's response to a particular drug, especially during drug trials.

Doctors could also use multi-gene analysis to diagnose a disease or predict what diseases a patient (or fetus) could contract later, paving the way for personalized medicine.

The push to lower costs is led by smaller firms such as Complete Genomics and Pacific Biosciences of California, who are known for their aggressive pricing.

The next major milestones in genomic research will be to build the computational systems and quantitative tools to apply these technologies to large numbers of people to determine the genetic mechanisms and treatments of human diseases, CSHL's Schatz said.

And, while funding may be squeezed, it won't disappear.

The research institutes still need to spend money because these government grants are such that if they don't meet one goal, they won't get the next leg of the grant. So they can't just not spend, said Macquarie's Groberg.