What is Happening to Pacific Biosciences Stock?
Someone once said that bankruptcy happens very slowly, then all of a sudden. That’s about how you’d describe the one stock we held until bankruptcy – Invitae (NVTA) – as it quickly went from growth story to deadly trap. Fortunately, we limit the amount of money we invest in any given stock to avoid chasing falling knives.
Today, we’re going to discuss a stock we last looked at just over a year ago – Pacific Biosciences (PACB) – a play on the exciting future of long-read sequencing.
The Long-Read Sequencing Thesis
Traditionally, genome sequencing has been performed using short-read sequencing (SRS) machines of the type produced by the undisputed short-read technology leader, Illumina (ILMN). While SRS provides accuracy, a more expensive type of sequencing – long-read sequencing (LRS) – allows for comprehensiveness as the name implies. That’s all set to change according to ARK Invest which expects the cost to sequence a whole human genome with LRS technology will drop to $100-$200, its accuracy superior to SRS across all variant types by the end of 2025. By that time the market will be worth $5 billion which is just over the $4.5 billion Illumina saw in 2023 revenues. Speaking of which, the Illumina Complete Long Read technology now appears to be commercially available though it’s said to be a cheap software substitute of the real thing. Unsurprisingly, Illumina disagrees.
According to experts at the University of Cambridge, there are only two stocks we ought to be looking at for long-read sequencing exposure – Pacific Biosciences (PacBio) and Oxford Nanopore Technologies (Nanopore). We invested in the latter which has seen shares plummet despite a rosy outlook of 30% revenue growth. PacBio followed suit losing more than 50% of its value yesterday as investors digested slowing – possibly declining – growth for this year. The problem seems widespread with even the industry leader, Illumina, expecting revenues to be flat this year with consumables growth stagnating. Life sciences companies are feeling the effect of macroeconomic headwinds and depressed valuations across the board reflect that. Below you can see the simple valuation ratio (SVR) for three names we’re watching in the LRS space.
Depressed valuations often make investors wonder if we’ll see some consolidation, especially since PacBio is now valued at a fraction of what Illumina was willing to pay six years ago.
An Acquisition Target?
In November of 2018, Illumina tried to acquire Pacific Biosciences in a transaction worth $1.2 billion. At that time, PACB was a much leaner operation with no long-term debt and no intangible assets. Today we see a balance sheet that’s far less attractive. The $1.7 billion in assets falls to $781 million when we remove the intangible assets and goodwill that arose from acquiring Omniome and Circulomics in the third quarter of 2021. When we subtract cash and short-term investments of $631 million, there’s about $150 million in assets left over. Contrast this to the $890 million in debt the company holds and we’re left thinking the odds of an acquisition that’s favorable to shareholders seem low. Potential suitors could include Illumina, but what’s the likelihood of succeeding the second time around? Thermo Fisher’s current attempt at acquiring Olink shows that regulatory scrutiny persists as their deal appears to be attracting attention from regulatory authorities.
Be very careful assuming there is some support level for PACB that involves being acquired. What they need is a plan to move towards self-sufficiency quickly because raising capital is going to be tough.
Surviving, Not Thriving
If you’re a PACB shareholder that’s underwater right now, don’t worry. You’re probably not the patsy at the table.
Nanalyze, April 2022
My, how things have changed. Shares of PACB have plummeted 86% since the beginning of this year making many investors wonder if they’re the patsy at the table. Last year we criticized PACB’s steep valuation – a simple valuation ratio (SVR) around 20. Today, that’s fallen to around two leaving us wondering, is this a quality company to invest in at a great price? PacBio is currently listed in our catalog as a “like,” but the balance sheet situation is becoming very concerning, especially considering stalling revenue growth.
PACB is burning a lot of cash – about $260 million in 2023. They’re estimating (at midpoint) to end 2024 with $443 million which means they’ll have reduced burn to $188 million a year. That gives them about 2.5 years of runway left (into 2027) before they’ll need to raise capital or reach positive operating cash flows. Management has talked about the latter, so that’s the option it seems they’ll take. (This was also Invitae’s game plan.) Taking on more debt doesn’t seem feasible so the only other option to raise cash would be to sell loads of depressed shares and further dilute existing shareholders. The company shares this sense of urgency as their last earnings call talks about the “journey to get to cash flow positive out in 2026,” though we’re wondering if that’s still feasible after the recent bomb drop.
Last Quarter’s Bomb Drop
Planet Labs has shown us how investors like to punish management teams which don’t have a good grasp on their business enough to provide accurate guidance. A few months ago, PacBio said “expect full year revenue to be between $230 million to $250 million. Compared to 2023, this represents a growth rate of approximately 15% to 25%, which we believe will be well above the sequencing market growth rate.” Those numbers were said to be muted given “the funding environment in China” and “persistent inflation and high interest rates are lengthening sales cycles globally.” Now we’re being told to expect $170 million to $200 million which represents no growth at the top end while the low end points to a 15% year-over-year decline. Below shows what revenues look like at the midpoint of the new guidance.
How is it possible for forecasts to change so dramatically in so little time?
As we reached the last couple of weeks of the first quarter, however, we saw an increasing number of customers delay instrument purchases and we experienced some unexpected softness in consumable shipments. As a result, the first quarter came in below our original expectations.
Credit: Pacific Biosciences
More details will be provided in their May 9th earnings call but the damage has clearly been done. The original PacBio plan was to target $500 million by 2026 based on selling Revio machines with associated consumables. Now we’re told that’s unlikely to happen. An internal reality check has shown that growth this year isn’t expected which collapses the entire house of cards. Our main concern is around PacBio realizing positive operating cash flows before they run out of money. A capital raise at these prices would have a devastating effect on dilution.
Thoughts on PacBio
Getting to cash flow positive means improving any number of metrics. Gross margin shows the potential for profitability, and PacBio’s 26% gross margins are relatively weak compared to Oxford Nanopore at 53% and Illumina at 65% (both are also declining over time). High-margin consumables help drive higher margins for an attractive razor-blade model, but recent comments about “small-to-mid-size existing customers yet to increase their sample volumes to drive an upgrade to Revio” mimics a concern we shared in our last piece on Pacific Biosciences. Does every R&D lab in the world need a Cadillac when a Toyota Corolla can get you down the same road?
You’re allowed to have revenue growth stall temporarily. That’s not uncommon these days. What you’re not allowed to do is whipsaw investors with guidance changes that imply management doesn’t have a good handle on the business. You don’t reward that by adding shares or going long. If you do decide to do that, wait and see what color they add during the May 9th earnings call.
We’re left wondering if the $919 million in goodwill on the balance sheet represents value for the $890 million in debt they took on to acquire it. Seems more likely than not they’ll need to raise capital to survive or take very drastic measures to control costs.
Conclusion
Saying we “like” a particular company means there is some likelihood we’d consider going long. PacBio isn’t a company we’d invest in based on their poor balance sheet, shrinking gross margins, and forecasts of slowing growth. Getting to positive operating cash flows by 2026 is critically important given how tough it will be to raise capital now. That focus on survival has now displaced any notions of growing to $500 million by 2026 which was the entire appeal of the long read sequencing thesis. Again, we start having flashbacks to when Invitae was singing the same tune. Call it being gun shy, but we’re going to avoid PACB until they can show a clearly feasible path to positive operating cash flows which would demonstrate an economically viable LRS platform.
