Ginkgo Bioworks Responds to Short Seller Report

Pumping and dumping a stock is illegal. Perhaps the most entertaining – and extremely accurate – portrayal of stock promotion was the movie Boiler Room in which a bunch of BSDs fleece the middle class before finally getting taken down by the SEC. Today, pumping seems to be the cool thing to do. Meme stocks are talked about as if they’re somehow democratizing wealth when the opposite is happening. Large Twitter accounts run by people of questionable character actually brag about pumping. They’ll look for low-float stocks and then pump them “to the moon” while an army of morons does their bidding. We’re not saying this individual with 594,000 followers is pumping stocks, they’re saying it.

Fortunately, the Department of Justice has started to crack down on Twitter users who run rackets, but the cult of crypto has already spilled over into equities. People are aggressively attacking anyone who says something negative about a stock they’re holding. That behavior used to be confined to stock promoters, but we’re seeing a lot more of it lately. People do not like it when you approach investing with a critical eye. That’s why our article titled Ginkgo Bioworks Stock Just Got a Whole Lot Riskier wasn’t met with a warm welcome by some.

Ginkgo Bioworks Gets Stung

Long story short, short-seller Scorpion Capital published a 175-page report on Ginkgo Bioworks which accused them of fraud. We’ve been huge fans of the work Ginkgo is doing, but this report raised some concerns. It’s easy enough to dismiss all the interviews conducted by Scorpion. After all, how hard is it to find disgruntled employees to badmouth their previous employer? And we also largely dismissed the extreme claims of fraud for several reasons.

First, the long list of institutional investors that vetted the company would have likely performed proper due diligence. (Yes, we know, Theranos, but they’re the exception, not the rule.) We also don’t believe that the inexperienced management team – the handful of individuals who developed the technology under the tutelage of Tom Knight – would be capable of such an act. What concerned us was the flippant initial response to the report given by the CEO, no formal response by the company in the days that followed, and a business model that indeed looks a bit shifty. In their most recent earnings call, Ginkgo Bioworks responded to Scorpion’s report, something that should put to rest any concerns around fraud.

Ginkgo Bioworks Responds

Shortly after the Scorpion Capital report came out, Ginkgo Bioworks received an informal inquiry from the Department Of Justice (DOJ). In response, Ginkgo arranged for an independent investigation that found any “suggestion of fraud, reporting violations, accounting errors, or other wrongdoing contained in the short seller’s report were unfounded and importantly that no restatement of our financials was needed.” When pressed as to where the DOJ inquiry sits, Gingko’s CEO responded with “there’s not too much more I’d add at this point on it.”

The delay in Ginkgo’s response is understandable given they were scrambling behind the scenes to deal with regulators. We had already assumed that fraud wasn’t an issue, and we’ll further assume this fraud thing is all wrapped up. Now, we can talk more about where our concerns really lie.

Not All Revenues Are Equal

When synthetic biology darling Ginkgo Bioworks first announced their intentions to go public using a special purpose acquisition company (SPAC), we opened a small position. Later, we adopted a rule to not invest in any SPAC whose merger hadn’t been finalized. So, we sold our position in Ginkgo Bioworks, intending to take another look once the deal closed. Today, we would never invest in Ginkgo Bioworks because it is overvalued according to our simple valuation ratio.

• Market capitalization / annualized revenues
  $17,930 million / (4 * 77.61) = 58

However, additional complexity arises when we consider the types of revenues being used in our calculation. First, let’s talk about “biosecurity revenues.”

Ginkgo’s Biosecurity Revenues

In late 2020, Gingko Bioworks was approved for a $1.1 billion loan from the U.S. International Development Finance Corporation for the purpose of aiding in America’s response and recovery to the COVID-19 pandemic. According to their latest filing, the company has yet to avail themselves of this loan, but they have been rapidly expanding products and services that are specific to The Rona. Today, the majority of revenues come from the Biosecurity segment where growth is “being driven primarily by K-12 pooled testing.”

The idea is that a pool of samples is taken from a classroom and tested. (The test is not FDA-approved because it’s a pool test.) The results are then provided to the requester only and not the health authorities. You can read more about the offering on the Concentric by Ginkgo website, but we don’t care to. If we wanted to invest in COVID test providers, we would. This distracts from the Foundry revenues we’re interested in, so let’s remove Biosecurity from the equation.

The next concern arises from Foundry revenues that are from “related parties.”

Ginkgo’s Related Revenues

One criticism made by Scorpion Capital surrounded “related party” Foundry revenues, something we shared concerns about in our last piece on Ginkgo Bioworks. The idea is basically this.

Ginkgo Bioworks funds STARTUPX with $100 million. Then, STARTUPX becomes a client of Ginkgo Bioworks and starts returning the money which Ginkgo Bioworks reflects as revenues. There’s nothing wrong with this per se, but we can all see why this raises some concerns. That’s why our focus is mainly on Foundry revenues with all related party revenues removed. Here’s that picture (2021 to date includes three quarters).

In the follow-up questions asked during the last earnings call, it’s clear that Wall Street analysts share the same concerns we have. When asked about the mix of “related party” Foundry revenues and third-party Foundry revenues, Ginkgo responded with “we generally see the mix shifting towards more third parties versus related parties.” Let’s hope that’s the case.

Ginkgo’s Foundry Revenues

Foundry revenues are tricky to analyze because Ginkgo Bioworks has different arrangements with every client they’re working with. Basically, payments come in the form of services rendered over time and “milestone payments,” the latter of which create some lumpiness in the Foundry revenue stream. Unfortunately, we may not have much insight into the contribution of each type. Says Ginkgo Bioworks:

We are internally evaluating this right now, but we do not anticipate that it will make sense for us to either guide to or breakout Foundry services revenue and downstream value share revenue as separate components.

Credit: Ginkgo Bioworks Q3-2021 Earnings Call

Our focus is mainly on Foundry revenues that do not include related party revenues, but let’s ignore that for right now. The estimates provided in the Ginkgo Bioworks SPAC deck are as follows:

They appear on track to deliver $100 million in Foundry revenues this year which is great. Since our focus is on Foundry revenues, we can calculate our simple valuation ratio using these numbers alone.

• 2021 – $17,930 million / ($100 million) = 179
• 2022 – $17,930 million / ($175 million) = 102
• 2023 – $17,930 million / ($341 million) = 53

If we only consider Foundry revenues, shares of Ginkgo Bioworks would need to trade at $2.69 a share or lower before we would consider investing in them (assuming 2021 Foundry revenues of $100 million).

Going forward, we’ll be keeping a close eye on Ginkgo Bioworks. The bull case has been made many times over. Synthetic biology is probably the single most disruptive technology we cover. Being able to program cells to do your bidding is akin to playing God. We love the story, but we’re not going to invest in it at a ludicrous valuation. And the promise of future milestone revenues isn’t compelling enough. As risk-averse investors, we don’t invest in promises.

Companies that develop organisms which cannot be commercialized won’t be users of Ginkgo’s platform for very long. We saw Zymergen make this mistake. Just because you develop a superior molecule doesn’t mean you can make money from it. In looking at their latest earnings call transcript, Ginkgo Bioworks talks about a $12 million milestone payment made by Cronos, a Canadian cannabis company trying to use synbio to produce cannabinoids. This is probably last on the list of items we’d like to see as a proof of concept. If Ginkgo Bioworks decides not to disclose milestone payments vs. services, it makes it increasingly difficult to see if molecules are getting traction.

Another thing we’re not overly fond of is when a company takes equity in companies in exchange for services. We saw Intrexon take this approach and fail miserably. We’d much prefer to see strong cash flows coming from the high-growth Foundry business as time goes on.

Conclusion

Whenever institutional investors strongly disagree on the future of a company, volatility increases sharply. You can bet that Scorpion Capital and Citron are still singing the same tune, and that risk-hungry ARK Invest remains as bullish as ever. Instead of getting caught up in the fracas, we’re watching from the sidelines and waiting for the dust to settle.

We’re not interested in Ginkgo’s COVID-related thesis, so our focus is solely on the progress being made in Foundry revenues. Should shares fall from their lofty valuation to approach something reasonable, and Foundry revenues show the growth that Ginkgo has predicted in their SPAC deck, we might start to like the stock, perhaps even enough for a long-term commitment.

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