Why We’re Selling Berkeley Lights Stock
If you decide to bare your investing decisions for the world to see, you better do so with conviction. Unless your thesis changes, you should never sell a stock. When additional information becomes available that threatens your thesis, you ought to examine it objectively and act accordingly. That’s why when activist short-seller Scorpion Capital released a 158-page scathing report today on Berkeley Lights (BLI), we needed to reexamine our thesis.
For those of you that don’t know about activist short selling, here’s a primer.
About Activist Short Selling
Shorting a stock means you’re betting it will fall. If you short a stock, then publish a report telling the world it’s shite, that’s an apparent conflict of interest. Consequently, you’d better be damn sure what you’re saying is truthful and have the legal resources to defend yourself regardless. A successful and legitimate short activist will often go to great lengths to prove a thesis because their reputation and money is on the line.
The firm that released the report on Berkeley Lights today is called Scorpion Capital.
They list one individual on their “About Us” page – Kir Kahlon – a man whose specialty is shorting life sciences companies. That’s how he’s made a living over the years, working for various hedge funds including a stint with the famous activist investor Carl Icahn. Consequently, you can expect his firm’s report to paint the worst possible picture of Berkeley Lights. Unsurprisingly, some of the verbiage is quite dramatic.
In our experience, synthetic biology is another meaningless term and may as well be a synonym for publicly-traded scam.Credit: Scorpion Capital
Bearing in mind that the author of the report is short the stock, let’s try and look for objective insights that help inform any decision we might make as a result.
The Scorpion Capital Report on Berkeley Lights
The report is an absolute beast, so let’s try and separate it into parts.
Customer and BLI Ex-Employee Interviews
The final 128 pages of the report are the interviews that Scorpion Capital conducted with customers (17 scientists and users across 14 of BLI’s largest customers.) and ex-employees of Berkeley Lights. Let’s assume the latter are all disgruntled employees with an axe to grind. As for the customer interviews, they talk about an overpriced machine with error rates around 50% that’s difficult to use. Pages 30-40 summarize the findings while the remainder of the report provides the detail surrounding each of the customer interviews. Let’s assume that Scorpion cherry-picked all the scathing interviews and omitted ones that spoke highly of Berkeley Lights. Still, the companies they’re speaking with are notable.
If we assume that at least several of the interviewees are speaking the truth about Berkeley Lights’ shortcomings, then that’s a concern.
A Long List of Red Flags
The reason Scorpion began looking at Berkeley Lights in the first place is because of lackluster growth. Since BLI released their one and only product back in 2016, they’ve placed a total of 92 machines. In short, the concern is that BLI isn’t managing the sort of revenue growth you’d expect to see from a company with a total addressable market of $23 billion. A dearth of academic papers citing BLI’s platform is raised as a concern, along with questions about the caliber of customer testimonials that seem to be missing any of the big names BLI is said to be working with or has worked with. (At the time of their IPO, BLI’s customer list included eight of the ten largest biopharmaceutical companies in the world.) That’s just the tip of the iceberg as the report goes on to cite numerous red flags uncovered through what appears to be an extensive research effort.
We need to make a decision based on the additional information made available today. There are three possibilities:
- Buy more shares
- Sell our position
- Do nothing
In light of this scathing report, and the uncertainties surrounding the AbCellera lawsuit we highlighted before, option one is off the table. That leaves us with one decision. Do we sell our position in Berkeley Lights?
Should We Sell Berkeley Lights?
Most readers probably don’t realize just how risk averse we actually are. Across the total sum of assets we’re managing right now, 21% is allocated to our tech portfolio. Of that, around 24% is in cash. That means our total exposure to tech stocks right now sits at 17.5% of total assets.
Let’s look at our Berkeley Lights investment which is one of several nanotechnology stocks we’re holding. We invested about 2/3 a position size worth of cash (2%). That’s since fell -50%, so our current position size is 1% of our tech portfolio. If the stock goes to zero, that’s what we stand to lose – about 1% of our tech portfolio value or about 0.23% of our total assets. There’s a temptation here to just “see what happens,” but that’s a lazy response. The correct thing to do is revisit our thesis – the reasons why we invested in BLI to begin with – which are clearly stated in our last piece on BLI titled Why is Berkeley Lights Stock Falling?
- They have loads of reference clients and they’ve demonstrated traction with growing revenues
- They’ve built a consumables-heavy platform that can be used to sort cells.
- They can cut the time it takes to do something important from weeks to days
Regarding the first bullet point, Scorpion just presented us with 128 pages of evidence that says reference clients aren’t saying nice things about BLI. What’s going to happen when BLI salespeople encounter objections that point to this report as a reason for not wanting to purchase their platform? True or not, some serious damage has been done.
As for revenue growth, it’s no doubt been flat for BLI, but we’ve been hanging our hat on this statement from the company:
Berkeley Lights continues to expect full year 2021 revenue to be in the range of $90 million to $100 million, representing 40% to 56% growth over the full year of 2020.
Scorpion Capital believes – with good reason – that it seems unlikely BLI will pull out two record quarters in a row to hit the lower range of their guidance.
As for our assumption that BLI is a “consumables-heavy platform,” that’s called into question by Scorpion’s report (page 21) which questions why consumables are not growing alongside the number of installations. This implies that customers aren’t using the BLI platform once they purchase it (something that’s backed up by their customer interviews).
The above might be dismissed as new customers still kicking the tires, but it doesn’t explain why consumables usage appears to have stalled over the past 12 months.
Several other concerns the report raised mimic red flags we’re always on the lookout for – customer concentration risk, and revenues from services/projects.
Three customers accounted for more than half of BLI’s revenues last quarter. Scorpion also notes a sharp increase in accounts receivables (money owed to BLI by their customers) which they claim is also a red flag.
When it comes to revenue mix, we see services and projects are becoming increasingly meaningful over time while product revenues remain flat.
We could continue to analyze the report’s findings, but we’ve seen enough. Activist short investors really stick their necks out when they make bold claims like this, and it’s likely that months of research went into Scorpion’s report. Where there’s smoke, there’s fire, and our original thesis has been called into question enough that we’re sufficiently convinced it’s time to purge Berkeley Lights from our portfolio and utilize our limited research resources on other stocks with less drama and consequently less risk.
What if We’re Wrong?
We cannot make decisions without conviction. If later today, ARK Invest issues an alert saying they went all in on BLI, and Scorpion Capital eventually is found to be guilty of libel, we’re not reversing our decision and buying back in. If Berkeley Lights hits two record quarters this year, and shares surge past their all-time high of $113.53 a share, we’ll live with it. We’re not going to second guess ourselves, we’re going to move our focus elsewhere and that’s final.
What we can do is try to learn from this. Here are the three major mistakes we made when analyzing and investing in Berkeley Lights.
- We didn’t understand what they did and all but said so – “The company uses lights to sort cells using semiconductor technology, and that’s about the extent to which we understand their technology.”
- We failed to initially identify customer concentration risk and monitor it over time
- We paid far too high a valuation for shares – This has since been addressed with our adoption of a simple valuation ratio
Regarding the first bullet point, the same can be said for other companies we’re holding. For example, could we really explain in detail how Schrodinger helps companies develop drugs quicker? Or explain the intricacies of the 10X Genomics platform? Probably not, but the difference between these two examples and Berkeley Lights comes down to adoption and revenue growth.
- Adoption – A lack of customer concentration risk shows that many companies are adopting the platforms
- Revenue Growth – Strong revenue growth shows that these same customers are using the platforms
Berkeley Lights has neither right now.
We’ve consumed a meaningful amount of time poring over Berkeley Lights, from before they decided to IPO until today. Every time the share price fell off a cliff, we quickly moved to research why. It’s the sort of investment that wastes a lot of time, and it seems that will continue to get worse. We’re selling Berkeley Lights because our original thesis has changed, and we feel that the opportunity cost of continuing to cover BLI in the face of today’s newly emerging drama is too high.
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