2023-06-15 01:44:28 ET
Summary
- 23andMe entered its IPO with two down years on revenue but has since reclaimed low double-digit growth.
- Throughout this time, however, the company has not made identifiable progress toward profitability on either an accrual or cash basis. It continues to use cash from the IPO for operations.
- This makes for a hold rating even though it is operating in a significant growth market, consumer genetics testing, that has a CAGR of over 20%.
Overview
23andMe ( ME ) is a direct-to-consumer healthcare company that provides DNA testing services to its customers. The two main product areas are health and ancestry services, with the former a much earlier-stage product development area. Ancestry services provides customers with a quantified overview of their ethnic composition and geographical origins. Customers send the company a sample of their saliva in the mail for tests.
While 23andMe was founded back in 2006, it only listed publicly in Q2 2021. After a brief initial rise it has depreciated significantly and trailed the S&P500 by more than 100% in terms of its price return. As of today it is trading with a market cap of $904.06M.
23andMe is an interesting company to consider due to it operating within a relatively nascent market - consumer genetics testing. This market is expected to grow rapidly in the near to medium term at a 22.3% compound annual growth rate. That makes it one of the fastest growth markets around, bar none; compounding 22.3% over 7 years yields a market that is 4 times as large as it starts at. Since the consumer genetics testing market was already at about $280M total revenues for 2022, it is expected to be a billion dollar yearly market by 2029.
This presents a significant revenue growth opportunity for 23andMe. Combined with its inexpensive share price this makes for a potential opportunity for investors, as well. Of course, the fundamentals still have to make sense. In this article I'll review the company's financials and determine whether this is the case.
Financials
Starting with revenue we see that 23andMe has been growing for the last two years but had declining revenues prior to that. It has now gotten to within $6M of its fiscal year 2019 (ending March 2020) but is still $140M away from its fiscal year 2018 (ending March 2019).
This is an uncommon revenue progression to see. While it is of course concerning that the company had such significantly declining revenues, it has also reversed the trend and maintained it for two years. I think there's something to be said for that.
Looking at its quarterly performance since its IPO, we see that 23andMe has been growing fairly consistently yet with a wide variance as to its growth rates. The most recent quarter has been the first quarterly y/y revenue decline that the company has posted since going public. However, this was due to o ne-off adjustments from the company's ongoing collaboration with GlaxoSmithKline . As such I don't think we can read too far into it and that growth this quarter would have been positive otherwise. Overall this allows for this to remain a good revenue trendline since the firm's IPO, albeit with significant variability.
Throughout this time the company has not been profitable and does not seem to have established a clear progression towards profitability as of yet. It has also lost cash from operations in most quarters.
23andMe is then a growing business that has not yet established profitable unit economics. I will note that this is not due to the economics of providing its services and that the company operates with a positive gross margin.
The persistent net loss stems from the firm's significant operating expenses, which have mostly continued to grow along with revenues. Since the 8 quarters since its IPO, SG&A expenses have risen in every quarter except 2. R&D expenses continued to increase throughout. This has resulted in the operating margin varying from -60% to -156% throughout this time. Last quarter saw this trend continue with an operating margin of -75%.
Overall it seems that the company is still focused on growth more than profitability. Given that this company does not operate profitably or generate cash flow, we must of course look to the balance sheet to see how it is maintaining its operations.
23andMe is not particularly leveraged, with $942M of assets and $228M in liabilities total. I will also note, however, that the company is still using the cash that it generated from the equity financing of its initial public offering. This figure has continued to decrease and there hasn't been any financing since.
Given the firm's lack of consistent progress on either income or cash unit economics, financing would not necessarily be readily available. At last quarter's cash burn rate of $45M, the company has 2 years and 1 quarter of operations left to go. That is still a good amount of time, but I think they would need to make progress on profitability sooner than that to be able to ensure debt financing. Further equity financing would dilute the stock further and would not be an appealing option at these prices. 23andMe is then tasked with figuring all of this out over the next 2 years.
The core risk to this stock is then that it does not develop sustainable unit economics in this time period and gets to a point where it is running short of cash. This would see the stock be sold off further, even though it is already trading at a discounted valuation. On a one-year forward basis the stock has a price/sales multiple of 3.37 at a 24.6% discount to the health care sector overall. Forward price/book is at 1.88 and a 33.9% discount to the sector overall.
Conclusion
There is secular upside here as well as a growing revenue base, but there are also other factors pointing to the downside. It doesn't seem that the situation for 23andMe stock tilts in one way or the other to any significant degree. On the upside it is operating in a significant growth market and has notched some stellar quarters in terms of top line growth. On the downside the company loses money on both a cash and an accrual basis and does not yet appear to have made much progress towards improving this. Until there is progress in that regard I would be cautious, even though the company has a reasonable balance sheet. As such I will rate it a hold for the time being.
For further details see:
23andMe: Revenue Growth And Secular Trend, But Lack Of Profits Makes It A Hold