I own $TXG as of June 15th, 2020. This is part of a new series I’m starting studying publicly traded biotech companies. The below is my take and analysis, but all investing decisions are your own. Their latest annual report and investor presentation are downloadable here.
10x Genomics is a provider of hardware and software tools for “academia, governments, other biopharma and biotech companies.” TXG’s products help these institutions research scientific solutions for a wide range of fields, including cancer, neuroscience, drug development, and beyond.
The 10x products have resulted in scientific acclaim (having helped their customers get 700-plus papers published in major science journals by using 10x tools) and patent defensibility (over 200 currently owned or exclusively licensed with another 480 pending).
Before explaining their solutions, the challenges these customers faced before 10x Genomics include (from page 5 of the TXG annual report):
- Average, or bulk, measurements obscure underlying differences between different biological units, such as individual cells
- Low throughput prevents requisite sampling of the underlying complexity–for example, when only a few hundred cells can be evaluated at a time.
- Limited number of biological analytes are interrogated, giving a myopic view of only a few biological processes….
- Inefficient use of sample to generate a signal of sufficient strength to analyze the biological molecules of interest
- Inadequate bioinformatics and software tools
In plainer English, even with modern advances, scientists still run into limitations in their ability to analyze, faster and in larger volumes, the smallest “biological units” like cells and their molecules.
How does 10x solve this problem?
The 10x Product Line and Revenue Model
10x has two main business lines: hardware instruments and “consumables”, inputs into the hardware (similar to how printers need ink cartridges).
Chromium and Visium
The main hardware product is the $75,000 “Chromium” machine that enables “high throughput analysis of individual biological components, such as up to millions of single cells.” Cell samples can be insert into the machine which then, simplified, separates cells based on common characteristics so that the individual cells or common groups can be studied separately from the larger sample.
“Single Cell” analysis is 10x and Chromium’s bread-and-butter. Examples of specific analysis customers use Chromium for include:
- Single Cell Gene Expression for measuring gene activity on a cell-by-cell basis;
- Single Cell Immune Profiling for measuring the activity of immune cells and their targets;
- Single Cell ATAC for measuring epigenetics, including the physical organization of DNA;
- and Single Cell CNV for measuring cellular heterogeneity through DNA changes such as copy number variations
Next is the “Visium” platform, which integrates hardware, software, and consumable components into one cohesive process.
Visium is a combination of proprietary slides and reagent kit plus complimentary software that enable researchers to visualize and study cells from tissue samples via “spatial analysis”. The integration of hardware and software provides a high resolution, three-dimensional view of genomic information being expressed in cells.
To understand the medical impact of the Visium product, here are some real-world applications of Visium helping to discover treatments for well-known diseases (from page 19 of the annual report):
Spatial analysis can be critically important in understanding tissue function in both healthy and disease states. For example, in the context of neurobiology, neuronal degeneration in the substantia nigra, an area of the brain associated with movement, results in Parkinson’s disease, while degeneration of upper and lower motor neurons results in amyotrophic lateral sclerosis, or Lou Gehrig’s disease. In the context of cancer treatment, the knowledge of whether T-cells have infiltrated inside of a tumor, rather than merely surrounding the tumor, is an important prognostic indicator. Understanding the spatial relationship of the biological analytes in tissues may hold the key to unlocking the underlying causes and identifying cures for such diseases.“
It’s worth noting though that what’s particularly compelling for customers is that most lab scientists are used to working with slides and reagents. 10x has found a unique way to fit new technology into the existing customer workflow.
An even more bullish consideration is that Visium just launched near the end of 2019, as the technology was a driver of the $38.6 million acquisition of Spatial Transcriptomics in 2018. Therefore, one could argue that Visium hasn’t even made its biggest contributions to 10x’s revenue yet and could be a growth driver going forward.
Recurring Consumable Revenue
This segues into 10x’s real money-maker: the “consumables” they sell that get used by the Chromium or other non-10x hardware.
These include “our proprietary microfluidic chips, slides, reagents and other consumables for both our Visium and Chromium solutions.”
An important unique consumable tech 10x has developed is the “GemCode” beads. The “Gem” stands for “Gel beads in EMulsion”. To again simplify the science, these beads act as unique color-codings for different types of cells. These are then used for partitioning the cells in the customer-provided sample.
In their words, “Our gel beads, which we manufacture in-house using proprietary methods, incorporate barcoded DNA molecules that are designed to react with the sample inside each GEM.“
Because these products are consumed, it creates a recurring revenue stream as customer continually restock their supply cabinets.
In 2019, 14% of revenue came from sales of the Chromium hardware, 84% came from the consumables, and the final 2% from other services sold.
Total Addressable Market and Growth Opportunities
There are a couple ways 10x sizes its potential opportunity: by similar hardware product units sold, and by annual dollars spent on similar tools.
10x’s 2019 annual revenue was about $245 million. Using either metric (50K units sold or $13 billion in annual revenue), they’re suggesting growth potential of about 50 times the current size.
This may seem outlandish. However, Thermo-Fisher Scientific, one of the leaders in scientific and industrial equipment, did about $25 billion in annual revenue last year.
A more conservative comparison is probably Illumina. As the leader in gene-sequencing hardware, they generated about $3 billion in revenue last year.
So 10x Genomics eventually getting to either the $13 billion or $3 billion target is possible and not unprecedented.
They employ approximately 100 commissioned salespeople, and maintain some third party distribution partnerships in certain Asia, South America, Middle East, and African countries.
The typical sales cycle is 4-6 months, presumably measured from first interaction (inbound or outbound) with the customer to receiving a purchase order. Page 82 of the annual report elaborates: “Our sales process varies considerably depending upon the type of customer to whom we are selling. Our sales process with small laboratories and individual researchers is often short, and in some cases, we receive purchase orders from these customers in under a month. Our sales process with other institutions can be longer with most customers submitting purchase orders within six months.”
Financials and Valuation
Addressing the bad news upfront, 10x Genomics has not yet produced positive net income.
With that acknowledged, there’s actually a lot to like in the financials.
- Top-line revenue grew 68% last year.
- Expenses declined 6%.
- Their September 2019 stock offering (IPO) generated $414 million in cash, giving the company already running near break-even a lot of runway to either achieve profitability or grow operating cash flows for sustainable reinvestment in growth and research and development.
Cash Flow Statement:
Without doing a full discounted cash flows model, I’m going to attempt to put a price on TXG stock by using a shorthand method:
- Compare financials to a similar company, Illumina
- Check if TXG is on the trajectory to match Illumina
- What are the implications for the stock price going forward if TXG follows that trajectory
As briefly mentioned before, Illumina is the industry leader in gene-sequencing technology. A basic example of what Illumina products do: give their hardware a DNA sample, they give you information on the genes that are in the DNA. So a similar business model in a similar field as 10x Genomics, but solving a different problem.
Below is a comparison of the current state of ILMN and TXG:
While TXG is smaller than Illumina in total dollars, investors are currently valuing TXG’s revenue almost twice as highly (the EV/Revenue multiple) as Illumina’s.
The reason for this is they are expecting TXG, being a younger company, to continue to grow faster than the older and larger Illumina.
Here is an example, but plausible, projection I’ve put together on how TXG’s revenue could grow while the rate of growth slows as the law of large numbers comes into effect.
One consideration a critical financial analyst might have is whether TXG can continue to growth that fast without overspending and losing money on sales and marketing.
Although sales expenses did increase nearly 50% from 2018 to 2019, the 68% growth in revenue would suggest the additional sales investments have a positive return. And with overall company expenses declining while revenue grew, TXG seems to be managing the balance between growth and cash well.
If the projections I put together come true, here is how investors might value TXG five years from now as a larger company closer to Illumina. This is for ball-parking purposes, so we’re ignoring some of the changes that might happen to cash and debt.
Even assuming investors lower the “multiple” they’re willing to pay over time as growth slows, we can see that the company’s enterprise value could possibly double to triple over the course of the next five years.
There are plenty of additional financial arguments that could be made for either pessimistic (not yet proven ability to produce positive net income) or optimistic ($1 billion in annual revenue is still nowhere near the total $13 billion opportunity TXG claims).
But I think the illustration above does a fair job landing somewhere in the middle with a reasonable investor conclusion, which is: the stock currently at $93 has a good chance to double to $180 over the course of the next five years.
How I Could Be Wrong
Below are reasons why the more optimistic view I’ve presented above could turn out incorrect and the stock underperforms expectations:
Hardware Pricing Declines
In 2019, they dropped the price of the fully featured Chromium from $125K to $75K. From the annual report, it’s not exactly clear why, but one would assume it was to make it easier to sell.
They do say in the report that they’ll try to avoid this in the future “by increasing the value proposition offered by our instruments and consumables, primarily by, for example, expanding the applications for our instruments and increasing the quantity and quality of data that can be obtained using our consumables.”
I would need better understanding of the customer discussions and price drop decision making process to know if this is a risk of happening again in the future, and thus potentially slowing revenue growth.
Single Source Suppliers
Some of the inputs into their hardware and consumable products can only be obtained from single providers.
They are trying to diversify their suppliers as much as possible (page 24 of the report): “While some of these components are sourced from a single supplier, we have qualified second sources for several of our critical reagents, including microfluidic chips, arrays and oligonucleotides. We believe that having dual sources for our components helps reduce the risk of a production delay caused by a disruption in the supply of a critical component.”
China as a Major Customer
43% of TXG’s revenue comes from outside the United States. China and Germany are the two largest markets outside the US.
Depending on how US-China political relationships change, TXG warns that the US government could restrict TXG from selling biotech to China:
In November 2018, the United States Commerce Department’s Bureau of Industry and Security released an advance notice of proposed rulemaking to control the export of emerging technologies. This notice included “[b]iotechnology, including nanobiology; synthetic biology; genomic and genetic engineering; or neurotech” as possible areas of increased export controls. Therefore, it is possible that our ability to export our products may be restricted in the future.”
Their Customers are Funded by the Government
Nearly 70% of revenue comes from academic institutions that are funded by government agencies (The National Institutes of Health in particular). Changes in the macroeconomy, US political parties, and/or policy changes could throw a wrench in how much money their customers have to spend.
10x Genomics is an intriguing investment because I believe biotech research will have a new, long-lasting relevance in society following Covid-19, even if some biotech stocks are currently overvalued and may decline again in the short term. So I’m overall long-term bullish on biotech.
Additionally, 10x’s approach is what’s sometimes called a “Pick and Shovel” play. TXG does not make drugs or therapies themselves. They provide tools to the people that do. This should mean their business is less volatile than their customers who may live or die based on government funding or the success of one medicine.
The combination of sustainable stability in a growth sector is hard to find.