Codexis Stock: A Risky Play on Enzymes

A great interview question to ask a fresh-faced MBA goes something like this. “Take the most sophisticated financial concept you know and explain it to me like I’m your grandmother.” It’s an elegant way to find out just how well a candidate understands the dreadfully boring financial concepts they’re forced to memorize, while simultaneously probing how advanced their understanding is in the domain. To understand a complex concept means you can then apply it properly.

The same idea holds true across all complex technologies. Synthetic biology can best be described as the ability to harness the greatest technology known to mankind – nature – and use it to produce things we need more efficiently, or perhaps create things that don’t even exist today. According to the bright minds over at McKinsey, “as much as 60 percent of the physical inputs to the global economy could, in principle, be produced biologically.” One company that hopes to harness the power of synthetic biology to generate great returns for investors is Codexis (CDXS).

We discover, develop and sell enzymes and other proteins that deliver value to our clients in a growing set of industries. 

Codexis

About Codexis

If you’re looking to hire superior candidates, you need a method for quickly eliminating the chaff. One way is to look for red flags. You’re always looking for reasons to dismiss a candidate during the first interview. If they don’t have any, and if they demonstrate some promise, then you get a few more VPs to grill them with tough questions. No “tell me what makes you happy” softballs.

Click for company website

The first time we grilled Codexis was way back in 2015 when they were going nowhere fast when it came to revenue growth. Their original focus on converting biomass to biofuels with Shell fell through, and the loss of that key customer impacted their revenues significantly. It’s exactly why we avoid companies with high customer concentration risk. Below you can see how revenues fell off in 2013 but have been steadily heading upwards since then.

Codexis annual revenues
Credit: Nanalyze

The red line in the above chart shows where 2021 revenues would be cut off without their biggest customer – Pfizer. Codexis talks about a “36% product sales 5-year compound annual growth rate,” but that number falls to just 7% with Pfizer out of the picture. Were it not for the $34.5 million in sales from Pfizer this year, 2021 revenue growth would have been a dismal 1.4%.

The second time we grilled Codexis was in August 2020 when we wrote about A Pure-Play Protein Engineering Stock that’s heavily reliant on a small set of customers for a big chunk of revenues. That problem only appears to be getting worse as Pfizer came on board in early 2021 with some serious enzyme needs related to the Rona.

Percentage of total revenues for Codexis 2021
Customer A is Pfizer and Customer B is Merck – Credit: Codexis

Pfizer and Codexis

In much the same way we don’t recognize Ginkgo’s COVID revenues when we value their business, we also view Pfizer’s COVID needs as temporary. In early 2021, Pfizer began purchasing a proprietary Codexis enzyme to be used in the production of PAXLOVID, an antiviral medication used to treat COVID which was granted emergency use authorization by the FDA for prescription use only (should be initiated as soon as possible after diagnosis of COVID-19 and within five days of symptom onset.)  Consequently, Codexis benefited greatly in 2021 with expectations that orders will continue.

We have received and currently expect to receive additional purchase orders from Pfizer for significant quantities of CDX-616 during the course of 2022 for delivery in 2022 and 2023.

Codexis

An article by NPR talks about how rapidly Pfizer is scaling up the production of their drug to 120 million courses. It’s tempting to look at the projected success of Pfizer’s drug as a proxy for the demand Codexis might see going forward. The problem is that we don’t know enough details to gauge how dependent Pfizer is on the proprietary Codexis enzyme which can only be produced as fast as the Codexis outsourcing partners that manufacture the enzymes. We don’t know what value the Codexis enzyme adds to the production process, or how critical that value proposition is going forward. Codexis talks about having “not yet executed a long-term sale and purchase agreement with Pfizer for CDX-616.” To date, these orders have been in the form of “purchase orders for individual deliveries of quantities of CDX-616 at mutually agreed upon pricing.”

If this enzyme was on the critical path of production, would Pfizer not want to put in place some contracts around “minimum quantities supplied?” Wouldn’t Codexis want to lock Pfizer in with a contract? Perhaps they don’t have the negotiating power to demand such contracts be put in place which would surely benefit their ability to plan.

In their 2021 year-end deck, Codexis gives strong revenue guidance for 2022 of between $152 and $158 million.

Codexis annual revenues
Credit: Nanalyze

They also talk about “$75M+ enzyme sales to Pfizer for the manufacture of PAXLOVID.” Using the upper range of their guidance, that implies projected revenue growth of about 17% with Pfizer revenues removed. Not bad, but consider that Pfizer will represent about 47% of total revenues in 2022. We want to see customer concentration decrease over time, not increase. Codexis may be enjoying some solid revenue growth, but they’re just too risky for our tastes right now.

Should You Buy Codexis?

We have no idea what you should spend your money on, but here are some ruminations from our think tank. Proteomics represents a tremendous opportunity for mankind to create proteins that aren’t found in nature and use them to produce the physical inputs for the global economy that McKinsey talks about. Here’s our favorite diagram which shows the undiscovered potential of nature’s amazing molecular machines.

Graphic image of all possible proteins
Credit: TED

In our piece on A List of 7 Proteomics Stocks For Investing in Proteins, we talked about various ways for investors to get exposure to the potential of proteins. For us, the ideal investment would be a company that sells machines and high-margin consumables, like Quanterix.

After falling 50% in the past four months, Codexis shares now represent a reasonable valuation according to our simple valuation ratio.

  • Market cap / annualized revenues
    1,258 / 98 = 13

Then again, so do all tech stocks these days. If you’re keen on investing in the company, be prepared for a great deal of volatility surrounding the uncertainty of revenues. The company talks about their relationships with key customers – Merck, Novartis, GSK, Takeda – but fails to provide information about the total number of customers using their platform. In fact, they explicitly say that customer concentration is not expected to decrease going forward. When a handful of BSDs are paying your bills, you have little negotiating power, and will spend all your time and energy pacifying them. These large companies have licensed the Codexis platform for their own uses, and will make payments based on how many successful proteins they’re developing on it.

Codexis' key customers
Credit: Codexis

The business model is more complex than just what’s seen above, and that’s another reason why this company isn’t one we’ll be investing in anytime soon.

Conclusion

Synthetic biology stocks have been a bust for so many years, and that continues to be the case as we see lackluster performance from firms like Zymergen (ZY) and Ginkgo Bioworks (DNA) which are down 91% and 72% respectively since the day their glamourous IPOs first began trading.

Codexis is showing promise, but the uncertainty of future revenue flows and customer concentration risk means it’s just a bit too risky for our tastes. Given all the uncertainty in today’s markets, risk is the last thing we want to be loading up on in 2022.

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