Here’s Why Invitae Stock Can’t Stop Falling
Loss aversion is a psychological concept where humans are shown to feel the pain of loss twice as much as the joy of gain. Even the perception of loss can result in pain. That’s why investors sweat paper losses when they haven’t actually lost anything. Over the past six months, shares of Invitae (NVTA) have dropped more than 80% leaving us with a position that’s now 86% below our cost basis. As we always say, the only reason to sell a stock is if growth subsides or our thesis changes. Invitae is a leader in genetic testing with revenue growth that shows no signs of stalling.
Provided Invitae hits their 2022 guidance, all should be well. So why is this life sciences stock dropping like a rock?
Why Is Invitae Stock Falling So Fast?
MBAs can create as many spreadsheets as they like, but the value of a stock will always be what investors are willing to pay for it. Today’s investor is putting less value on the promise of future growth, which is why many disruptive tech stocks are plummeting. That’s understandable, but more seems to be happening with Invitae. Investors may be punishing the company because the road to profitability is a long one, and the firm’s capital raising options are limited based on their past actions.
We’ve talked about how companies with strong gross margins are better positioned to reach profitability when easy capital dries up. Simply take the war chest of cash raised during good times and make it last until you’ve cut enough fat to reach profitability. One problem Invitae faces is that their gross margin isn’t all that great at 21%. (It’s one of the lowest in our entire portfolio.) That problem becomes exacerbated when you consider how badly they’re positioned when it comes to available capital and the potential to raise more in the future. Let’s start by looking at their cash burn.
Invitae’s Cash Burn
Earlier this month, Invitae released their Q1-2022 earnings results in the form of a 10-Q and accompanying investor deck which shows the company dramatically reducing cash burn over the next several years. We’re not sure if “extend our cash runway” means they already did, or they plan to, but their most recent earnings call talks about “efforts to extend our current cash runway well into 2023 or beyond.”
Let’s hope the runway extension plan comes to fruition because the same deck says they’ll reach positive operating cash flow by 2025. So how do they plan to fund their existence until then? Here’s our back of the napkin math:
- Cash and marketable securities of $885 million as of Q1-2022
- $169 million burned in Q1-2022 with $600 million burn anticipated for 2022 = $431 million on books exiting 2022
- If they cut burn in half during 2023 compared to 2024, that leaves them with $131 million going into 2024.
That happens to be the same year in which $350 million in 2024 notes and a 2020 Term Loan of $135 million become due. The latter was taken out with an outfit called Perceptive Capital and consists of a credit line that maxes out at $350 million of which Invitae has taken out $135 million. They’re not allowed to prepay without a penalty, and the debt document is filled with covenants such as minimum required revenues, minimum cash that needs to be on hand, limitations as to what debt they can raise, and the list goes on. Just why did Invitae feel the need to back themselves into a corner with a restrictive debt package when – at the time they took on the debt – shares were trading at over $40 a share?
Our 2020 Term Loan bears interest at an annual rate equal to three-month London Interbank Offered Rates, or LIBOR, subject to a 2.00% LIBOR floor, plus a margin of 8.75% and is therefore sensitive to changes in interest rates.Credit: Invitae 10-Q
All those restrictions and they couldn’t even manage to get a decent fixed interest rate. Sure, it’s a small loan, but what purpose did this serve other than to increase risk? It also sets the wrong tone when Invitae goes to the negotiating table to refinance existing debt or raise even more debt to fund their operations. Based on the $1.635 billion in debt obligations they have now, raising more debt seems like a tough hill to climb.
If we consider cash on hand of $885 million and convertible notes plus debt of $1.635 billion, Invitae isn’t looking too hot. Now that capital markets have dried up, they seem to have been caught with their pants down as the tide goes out. Raising capital is no longer easy or cheap. We have concerns about how they plan to raise the money needed to survive until they become cash flow positive in 2025 – if they become cash flow positive in 2025. If you thought the terms on their existing debt are rough, wait until you see what lenders will require for Invitae to raise even more debt. That hardly seems like an option, so they’ll likely have to sell more shares. In 2021, Cowen and Company (an investment bank) was authorized to sell up to $400 million in shares at Invitae’s discretion. As of March 31, 2022, Invitae had 228.8 million shares outstanding, up nearly 16% from the same period in the year prior. Investors should watch this number closely for further dilution. From the horse’s mouth:
Additional funding may not be available to us on acceptable terms, or at all. In addition, the terms of our credit agreement restrict our ability to incur certain indebtedness and issue certain equity securities. If we raise funds by issuing equity securities, dilution to our stockholders would result.Credit: Invitae
With shares at rock bottom prices, now is not the time for Invitae to be raising capital by selling shares. As for debt, that’s not likely to come easy either. In addition to the aforementioned $135 million they owe from a total possible $350 million credit line, Invitae also has nearly $1.5 billion in convertible notes on their books, $350 million of which comes due in 2024. The other $1.15 billion in convertible notes comes due in 2028 courtesy of SoftBank’s previously deep pockets.
Should You Buy Invitae Stock?
We have no idea what you should do with your money because we know nothing about your age, dreams, desires, tolerance for risk, and what your future ex-wife has to say about the whole thing. That said, there are a finite number of outcomes for our Invitae position. We’ll be holding off on any postmortems until one of the following events happens.
Invitae Pulls an Amy Winehouse
If Invitae defaults because they took on some dangerous debt, shares will probably pull a Bind Therapeutics and be worth eff all. If that happens, we need to know how much we stand to lose. The answer is, not much.
Diversification is important because it allows you to make mistakes without ending up in the poor house. Invitae is a great example of why we don’t sweat paper losses. Even if the company went bankrupt tomorrow, our invested capital as a percentage of total assets under management (AUM) would have only decreased around 0.66%. That’s why we always limit the amount of capital invested in any single stock.
Invitae Gets Acquired at a 200% premium
The problem with holding a stock that’s 86% below your cost basis is that it needs to increase by +640% just for us to break even. If Invitae were acquired tomorrow at a 200% premium, we’d have lost more than half our investment. Someone raised this concern recently in one of ARK Invest’s webinars. With all the disruptive tech stocks trading at bargain-basement prices, what happens if they start being acquired and shareholders who are underwater have their losses locked in? ARK’s response was that they’d fight against such acquisitions, so that’s a vote of confidence. But if things at Invitae start to go pear-shaped, an M&A event might be the only viable option.
Our Invitae Thesis Changes or Growth Stalls
If you think Invitae is trading at bargain-basement prices now, just wait until something really bad happens. If our thesis changes, or growth stalls, or Invitae defaults on debt, or any other company-specific event happens, there won’t be much value left in our position to sell. Going back to our earlier point, it’s important for risk-averse investors to only commit a fixed amount of capital and not try to catch falling knives.
Nobody watches a stock drop 86% and thinks to themselves, “what a bargain!” We’re always prone to start questioning our original thesis and checking to make sure things haven’t changed. It’s the safest thing to do as risk-averse investors. After checking in with Invitae, we believe our thesis hasn’t changed a bit. What has changed is the company’s access to easy capital. They may have backed themselves into a corner with some pretty restrictive debt obligations, a big pile of debt, and a share price that will only serve to dilute existing investors if they sell shares to fund their operations. And based on what we’ve discussed today, that seems to be the only way they’ll be able to survive until 2025.
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