BNGO - Bionano Genomics: Little Clinical Utility And A Whole Lot Of Burn

Summary

• Bionano Genomics makes a machine to perform optical genome mapping, a useful technique for understanding chromosomal damage.
• We contend however that there is little utility for this device outside of the research lab and that the market is too small to support the company's $100 million burn rate.
• Bionano would need to increase its sales by orders of magnitude to reach cashflow positivity, which we do not think is possible. Sell BNGO.

Editor's note: Seeking Alpha is proud to welcome Harrier Capital as a new contributor. It's easy to become a Seeking Alpha contributor and earn money for your best investment ideas. Active contributors also get free access to SA Premium. Click here to find out more »

We are short Bionano Genomics ( BNGO ) because we contend that its product the Saphyr system has very limited utility in the clinical setting, and the basic research market is too small for the company to achieve cashflow positivity. This is compounded by the company's poor margins and very large burn rate. In the past 12 months the company earned a gross profit of $3 million on an operating cash burn of $106 million. We do not believe that they will be able to bridge this gap without an enormous increase in the number of systems they have placed. To date, 196 Saphyr systems have been sold since the company's inception.

Company overview

Bionano is a life sciences company that is developing a new class of devices that gather genetic data. The company has developed a platform called the Saphyr device for performing Optical Genome Mapping (OGM). OGM is a process of identifying large changes to the structure of chromosomes. Much genetic research focuses on identifying mutations or small changes in the sequence of A, T, G, and C base pairs in the genetic code. OGM is different in that it is looking for changes on a much larger scale, measured in the millions of base pairs. It can identify large deletions, duplications, translocations, and other changes to these chromosomes.

The Saphyr system itself does this using a combination of microfluidics and genetic barcoding. A simplified explanation is that a chromosome is drawn out linearly into a microfluidic tube and then labeled with fluorescent barcode molecules. If these barcodes do not appear on the chromosome in the expected order, the system then concludes that a deletion, rearrangement, or other change has occurred. These large chromosomal rearrangements are implicated in a number of diseases. Such damage to genomic structure is common in cancer cells and can contribute to their pathogenicity. Also some chromosomal defects are congenital and can underlie genetic diseases. It is the only device of its type.

The question then becomes, what is the demand for this type of data? There are two main markets for this product: basic research and clinical diagnostics. Basic research is the process of discovering new science, and include both the new science discovered at universities and hospitals as well as in the private sector at pharmaceutical companies or similar. The clinical diagnostic market, by comparison, would be the application of this device directly to human health by analyzing human samples for genetic defects. This could conceivably be used to guide treatment for cancer or to identify a congenital defect.

The basic science market

One detail that should be made very clear is that there is little debate as to whether the Saphyr system works as designed or the quality of data produced. By all accounts the product works and produces rich data. We believer OGM clearly has a place in scientific research that currently can't be replicated by any other technology. There are multiple other techniques that can identify structural variations in chromosomes, but these methods simply do not find as many defects as the Saphyr system. These facts have been enumerated in multiple scientific publications - for instance, in this recent paper that the company press released showing that OGM found substantially more genomic defects than sequencing.

However, OGM is not the multipurpose solution that sequencing is. Unlike sequencing, we believe that its main utility is for scientists that are vested in cataloguing and understanding these structural variations. Sequencing, by contrast, is used almost universally by biologists.

The system has a high capital cost as well, which limits the number of labs where it can be placed. The company doesn't make pricing information easily available, but based on their reported number of sales per quarter and their product revenue, we estimate a price of around $200,000. As with other high capital cost equipment like sequencing machines, the product will likely appear in core facilities where multiple research groups can utilize it as needed. This limits the customer base to one potential purchaser per institution for most universities and hospitals and a small number for the biggest pharmaceutical companies.

There are only 227 R1 and R2 research universities and 144 medical schools in the United States. This severely limits the potential academic market for the product. A bigger potential market segment is pharmaceutical companies of which there are approximately 2000 in the United States, although only a small portion of those companies will have a use for this product. That corresponds to a total revenue potential of approximately $480 million if every single one of these institutions were to buy a single machine. The company has sold 196 Saphyr machines today, primarily into this market, so it has achieved 10% penetration on the low end of the estimate.

The main conclusion here is that we believe that the basic research market, although the most appropriate for the device, is simply too small to support this company alone.

The diagnostic market

Because of the small size of the research market, the future of this company rests in large part on the utility for the Saphyr system to perform clinical diagnostics. An example of a use case in a diagnostic setting would be when if a person is diagnosed with breast cancer, OGM can be performed to identify if that patient has any specific chromosomal rearrangements that could guide treatment.

One issue the company is currently facing is that there aren't very many good use cases in cancer where the product can provide actionable information. For instance, in the above example with breast cancer, there aren't any medications that target specific chromosomal rearrangements, and the data gathered by OGM likely would have no impact on the treatment course. In fact, there is only one example we are aware of where a chromosomal rearrangement guides treatment, which is the Philadelphia chromosome.

OGM is overkill for most applications in this setting. When a particular genetic factor is determined to be important, like the Philadelphia chromosome, a low-cost test is developed to identify that specific defect. For instance, here is a discussion of the specific test for Philadelphia chromosome. The situation is similar for genetic disease where once a defect is identified, a test is developed. These tests typically use fluorescence in situ hybridization or FISH, a decades-old commoditized biochemical technique.

The company has also discussed using its platform in the setting. CLIA, which stands for Clinical Laboratory Improvement Amendments, is an act of Congress that established a process by which a clinical lab can provide a test that isn't approved under the FDA's review process. This is just for individual labs where samples will be sent from hospitals and clinics. This again centralizes the use of this machine, instead of getting it placed more widely into hospitals, but it is a potential market segment.

In 2019, Bionano placed a machine at PerkinElmer , which is using the product in a CLIA lab to provide testing for a form of muscular dystrophy. The company also operates its own testing facility through their Lineagen subsidiary, which provides testing for autism of neurological disease; in September 2022, the company announced that it would be also testing for this form of muscular dystrophy. Bionano does not report revenue from this segment, so it's hard to gauge if this strategy is working, but in Q2 2022 the company reported that a total of 373 samples were processed.

The main problem with the company entering the diagnostic market is that it is a solution without a problem. One would have to assume then that somewhere, sometime in the future some very important test is discovered that can only be done on this machine, and that is a lot of speculation.

A very steep financial hill to climb

To give Bionano some credit, it is generating revenue despite the above difficulties, and this revenue has been growing significantly. In Q2 2022 the company reported sales of $6.6 million up from $3.8 million in Q2 2021. Quarter-over-quarter growth has been steady except for quarters deeply affected by COVID.

However, Bionano makes very little gross margin on these sales. Its capital sales have a gross margin of approximately 25% historically, but in recent quarters it has been 0% or negative. In total when including service revenue, the company has gross margins of 15-33% approximately.

Also, during the same timeframe, Bionano's costs have exploded. Q2 2022 had operating expenses of $33.5 million compared to $17.9 million in Q2 2021. As mentioned above, the company has burned over $100 million in cash over the past 12 months.

This has set up an extremely dire situation for the company. Based on the economics of the last reported quarter (Q2 2022: 22% gross margin, $6.7 million in revenue, $33 million in operating costs), the company would need to increase its sales by 23x to just cover its costs. The basic research market is far too small to support this, and the diagnostic market would need some blockbuster test to materialize that doesn't exist now.

Bionano ended Q2 2022 with $187 million in cash, which is about 6 quarters at the current run rate. However, like I mentioned above, that burn rate has increased dramatically over the past year and this may continue. Part of this increase was the acquisition of BioDiscovery (a company that provides software to process OGM data), which happened in Q4 2021, but the company cites increases in spending across the board in their Q2 2022 earnings call.

The company currently only sells about 10 to 20 devices a quarter (based on the company presentation). To put a finer point on the hurdle they face, to hypothetically break even in the next quarter they would need to sell a new device to every research university and medical school in the United States, and then 100 more somewhere else. This is also assuming that service revenue will scale in line with new placements. The result is that this would over double their current number of placements to approximately 460 (from 196). This is what they need for a single quarter to just break even.

Valuation

With the above in mind, we think it is self evident that this company's business model is unsustainable. We believe there is unlikely to ever be a market for this product that is large enough to justify the company's burn rate. The company has been compounding its losses, so this burn may continue to increase. We believe that the story of this stock will mostly be told through earnings, as they continue to burn cash, and fail to expand into larger markets. Given the current cash runway, Bionano will likely need to raise capital in the next year.

As we see this as a perpetually cash-burning enterprise, we believe that the fair value of this business is below cash. There is no scenario in which this company achieves cashflow positivity before it reaches the end of its current cash runway, and we believe that it will similarly destroy any additional capital it raises. At current share prices, a $100 million raise would dilute the company by 18%. We can then expect this type of dilution yearly just for the company to support its burn rate, even if we assume no other change in its EV. However, as the trajectory of this company towards insolvency continues, we believe that there will be little hiding this fact, and that the EV will eventually reach zero. There is no other meaningful way to calculate an NPV on a company that will never have positive cashflow.

Certainly, I hope we can agree that the 196 Saphyr units this company has shipped aren't worth over $600 million in market cap.

Risks

There are two scenarios in which our short thesis is incorrect: the company happens to discover an important use for its product, or the company is bought. We are not hugely concerned with these risks, understandably. We actually do believe that the product could be used in the discovery of new genetic markers, but like we mentioned above, once these markers are discovered, simple tests are developed and you do not need the all-encompassing approach of OGM.

We also believe that the risk of a buyout is limited. An acquirer would among other things need to fix the gross margins on this product. It is expensive to buy, expensive to market, and expensive to make. This is in addition to all the arguments above about the small market size. Acquiring companies will be doing the same analysis as here, and we think that the very limited sales that this product has been able to capture make a buyout unlikely. Moreover, any acquirer could wait until the company is insolvent and get a better price.

The only other factor to consider is if the market continues to value genetics companies like Bionano at huge valuations. There is reason to believe that this bubble is deflating. The ARK Genomic Revolution ETF ( ARKG ), which one can implicate in the current bubble, is down 57% in the past year.

As of writing this the stock has approximately 15% short interest as a fraction of the float, and rates have been in the low single digit range. We don't see this as a particularly risky trading situation, but we will be keeping an eye on the short interest as knowledge about this company increases. Alternatively, options are available for the stock but the market for them is thin.

Conclusion

We believe that this is a company that got ahead of itself. The product they sell is useful, and there is a little demand for it out there, albeit not enough to support the current business by a large multiple, and not enough to justify this being a public company. We would have no problems with this company if it could maintain spending more in line with the actual utility of the product. But we believe that the easy public money this company was able to raise during the genomics bubble has led to a bloated organization selling a product that barely has a gross margin.

We hope that the Saphyr system can continue to improve our understanding of genetics, but we believe that that is where its utility ends.

For further details see: