Four AI Drug Discovery Stocks On Sale – 50% Off
Using artificial intelligence (AI) to optimize the drug discovery process is an AI healthcare thesis that’s probably one of the more appealing and least mature when it comes to how machine learning will change industries. While themes like robotic process automation (RPA) and AI chips are reaching maturity and reaping rewards, we’ve yet to see some real breakthroughs come out of using machine learning to develop new drugs.
In September of last year, we published a piece Comparing Four AI-Powered Drug Discovery Stocks, one of which – Exscientia – was preparing to IPO. Here’s how those firms have performed since then (company names link to our research):
|Company Name||Ticker||Market Cap Then||Market Cap Now||Change|
The share price of all these firms has at least halved in less than six months. Why?
Pick your poison. There’s been a tech stock correction. Interest rates are going up, so the value of a dollar today is worth more than the promise of a dollar tomorrow. Oil is soaring. The Russians are on the move. The Americans are becoming weaker because of infighting. The Chinese are eyeballing Taiwan like a fat kid looks at cake. And the list goes on.
While we don’t believe that investors are truly showing fear yet, we do believe that some selective purchases are in order as quality companies plummet. Of the four stocks mentioned above, we’re only holding one. If we add some shares to that position, Nanalyze Premium annual subscribers will be the first to know.
Plummeting Valuation Ratios
Regular readers know that we use our simple valuation ratio to see how stocks compare when it comes to valuation. Here’s what that number looks like for Schrodinger based on today’s prices:
- Market cap / annualized revenues
2,180 / 185 = 12
The number 12 hardly means anything unless we compare it to something. For example, we believe that any stock over 40 is too richly valued. The importance of the number 40 is irrelevant, it’s just important that you have a cutoff number – a rule in place that makes sure you don’t overpay for stocks.
Valuations for tech stocks have been plummeting. Here’s a look at some valuations for life sciences stocks we’ve been covering over the years (company names link to our research).
|Asset Name||Market Cap (millions)||Last Quarter||Last Quarter Revenue (millions)||Nanalyze Valuation Ratio|
When it comes to AI drug discovery companies with no revenues, or very little revenues, or sporadic revenues, our valuation ratio doesn’t work so well. So, let’s look at another way we can value such stocks.
Valuing Recent IPOs
Most companies only come across the radar of retail investors when they have an initial public offering (IPO). All of the companies we’ve talked about today used a traditional IPO process, but lately, special purpose acquisition companies (SPACs) have provided a much more convenient way to go public, albeit one that doesn’t do retail investors any favors. Regardless of how a company chooses to go public, they usually took funding at some point beforehand from very sophisticated institutional investors. Since all these companies used a traditional IPO process, we can easily see what institutional investors paid for their shares and compare that to what shares trade at today.
|IPO Date||Price Paid||Today’s Price||Difference|
Of the companies listed above, we think there’s a solid case to be made for Recursion Pharmaceuticals.
Making a Case for Recursion
For most companies, there are additional valuation data points we can examine which are available prior to a company going public. For example, Recursion Pharmaceuticals raised a Series D round of $234 million in September 2020 with Bayer as the lead at a valuation of $1 billion. In other words, one of the largest pharmaceutical companies thought Recursion was fairly valued at $1 billion just 18 months ago. Today, Recursion is valued at $1.2 billion. You’re only paying a premium of 20% over what Bayer did 1.5 years ago and 61% less than the $18 a share they priced their IPO at. So, we can say you’re certainly not overpaying for shares right now, though we’re certainly not calling a bottom.
Here’s what we said about Recursion back when we covered their IPO in a piece titled Recursion Stock – Revolutionizing Drug Discovery With AI:
The sheer breadth of compounds they’re exploring, their bedmate Bayer, and the large amount of big data that’s growing at an exponential rate are all reasons we think Recursion won’t go the way of Bind Therapeutics.Credit: Nanalyze
We believe that Recursion seems to have the most promising future based on the scale at which they appear to be operating. Because of all the external risks, drug discovery is largely a gamble with an uncertain likelihood of a payoff. Your odds of winning increase with the number of chances you have. If, as Recursion claims, they have, “one of the largest, broadest and deepest pipelines of any technology-enabled drug discovery company,” that makes them more compelling than the rest.
Recursion shares fell off a cliff last week because the GM2 Phase 2 trial start will be delayed by approximately 2 years among other guidance given. The reaction is appropriate because the company can only expect to achieve meaningful revenues if drugs advance through their pipeline. Of the estimated 50 drugs they’re currently developing, four are in Phase 1 trials or preparing to advance to Phase 2 trials as follows:
- GM2 Gangliosidosis – delayed Phase 2 trial start by two years
- Cerebral Cavernous Malformation – Phase 2 trial enrolls first patient in coming weeks
- Neurofibromatosis Type 2 Phase 2 portion of adaptive Phase 2/3 trials on track to enroll in Q2 2022
- Familial Adenomatous Polyposis expected to enroll the first Phase 2 patient in either Q2 or potentially Q3, 2022 cuz Rona
All eyes are on these four candidates because the success of just one will help validate the platform. Likewise, any failures won’t bode well for proving the underlying value proposition which is to increase the likelihood that drugs make it through the FDA’s drug approval gauntlet.
Our Thoughts FWIW
We’ve always been tempted to invest in Recursion because it’s a spectacular story. But we don’t invest in stories, we invest in revenues. For drug discovery companies, revenues usually mean that drugs have been successfully developed, at which time the share price will reflect that optimism. Were it not for what’s happening in today’s markets, we’d be tempted to make an exception to our “don’t invest in companies without meaningful revenues” rule for Recursion given the valuation analysis we performed today. We’re able to invest in the company at a 20% premium to what Bayer did prior to the IPO and a 61% discount on what shares were priced at during the IPO. But then we remind ourselves that we’re moving slowly in 2022.
Here’s one way to look at Recursion. Let’s assume that this platform works as expected and can predict successful drugs half the time compared to the current industry success rate of less than 10%. If that’s true, then half these pipeline drugs will be successfully commercialized. With 50 drugs in their pipeline and growing, the first successful drug will only represent 1/25th of the company’s potential. If we simply wait for one drug to clear clinical trials, a great deal of risk will have been removed as revenues start flowing in. Wait for the dust to settle and invest then. Whatever premium we pay as a result of waiting is worth avoiding the risk of them going bust waiting for their first success story. Investors with a higher risk tolerance could start adding shares much earlier.
On the other hand, let’s assume that the platform doesn’t add the value it proclaims. The first time a drug fails to progress through clinical trials, that’s a huge red flag. Remember, we’re assuming that the platform does what it says on the tin per this diagram provided in their S-1 filing.
The entire value proposition surrounds the fact that they’re able to identify failures earlier in the research cycle.
Other Drug Discovery Companies
We also need to consider the many AI drug discovery companies we’ve covered over the years that haven’t gone public yet. In their latest investor update, Recursion published an interest chart that shows their competitive position relative to some of the other big names out there.
The above needs to be taken with a grain of salt considering it was commissioned by Recursion, but it still provides a good framework to think about how these companies compare. Benevolent AI is planning to go public using a SPAC (ugh), while Insilico is said to have filed confidentially for an IPO. In the future, there may be more names to choose from other than the four AI drug discovery stocks we’ve talked about today.
Lastly, to the Schrodinger investor relations team, we know you don’t want to be called an AI company. We’re willing to look past the fact your last 10-K uses the phrase “machine learning” 31 times and acknowledge that you’re a “physics-based computational platform,” but we’ll probably still consider you in these types of comparisons mainly because others do as well (per the above chart).
As stocks plummet to new lows, beware of trying to catch falling knives. One way to establish a “bottom” for stock prices is by looking at what institutional investors have been willing to pay in the past. The four drug discovery stocks we’ve looked at today trade at discounts based on how much they’ve fallen in the past six months and what institutional investors paid at the time of their IPOs. For investors who have an appetite for risk, these names might be of interest. As market pundits who add no value like to say, proceed with cautious optimism.
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